Penn...After Hours
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Headlines for the Month of Sep 2023
Th, 28 Sep 2023
Aerospace & Defense
Lockheed Martin lands two big F-35 deals with Romania, Czech Republic
Two former Warsaw Pact nations, now both staunch US allies and members of NATO, have signed agreements to purchase advanced Lockheed Martin (LMT $411) F-35 Lightning II aircraft in an overhaul of their respect air forces. Romania will purchase 32 of the fifth-generation fighters for $6.5 billion, while the Czech Republic has approved the purchase of 24 F-35s for around $4.5 billion.
Romanian Defense Minister Angel Tîlvăr said the purchase will give the Romanian Air Force state-of-the-art capabilities “in the security architecture on NATO’s eastern flank and in the Black Sea region.” Following the purchase of these two 16-aircraft squadrons, the country also said it may pursue an acquisition of a third squadron.
As for the Czech Republic, the deal was a bit more controversial. The Czech Air Force’s top fighter is currently the Gripen, which it leases from Swedish aerospace and defense firm Saab AB (SAABY $27). After months of lobbying by the defense ministry, the government of Petr Pavel agreed to ditch renewing the lease—set to expire in 2027—in favor of the purchase, which will include simulators, pilot training, and a weapons package. Prime Minister Petr Fiala said the deal “is an effective solution” which will “solve the future of our tactical air force for decades to come, in contrast to (continuing to lease) older generations of fighter aircraft.” Prague is planning to rebuild its Caslav Air Base to accommodate the new fleet.
The F-35 is rapidly becoming the cutting-edge fighter of choice among Eastern European countries, with production of a previous order from Poland ramping up this year at Lockheed’s Fort Worth, Texas assembly lines.
We believe Lockheed Martin is the strongest player in the global aerospace and defense industry, not just within the United States. Boeing (BA $193) continues to prove it never should have been allowed to buy McDonnell Douglas, a fierce competitor in the space until the acquisition, as the company can’t seem to stop mucking up its military and civilian operations on both the aircraft and space sides of its business. We also believe that investors are underestimating Lockheed’s leadership role in the industry going forward. We would place a fair value on LMT shares at $550. Consider the recurring income stream from maintaining all of those F-35s around the world over the next several decades, and then consider that this is just one component of the company’s massive array of space and defense products and services.
We, 27 Sep 2023
Multiline Retail
Target announces the closure of nine stores in crime-ridden areas
It is a horrendous problem and a sad testament on the current state of American society. Organized crime has become so rampant at bricks-and-mortar stores that major American retailer Target (TGT $109) has announced the closure of nine locations in four states to protect their employees from physical harm. The affected stores are in New York City, Seattle, San Francisco, and Portland.
Target, which operates at 1,950 locations across the country, becomes the first retailer to specifically blame crime for the shuttering of stores. While many management teams have shied away from discussing the problem during quarterly conference calls, CEO Brian Cornell has been shining a spotlight on this disgraceful situation. While Target earned nearly $3 billion in profit during the most recent fiscal year, Cornell said he expects the company to take a $500 million hit this year due to theft.
The industry is pushing Congress to pass the Combating Organized Retail Crime Act, which would create an organization within the Department of Homeland Security to better align federal, state, and local law enforcement agencies engaged in the fight. It would also impose harsher penalties on offenders, and force online marketplaces to step up their vetting of vendors to help assure stolen goods stay off the sites. One major challenge has been the lack of willingness on the part of certain jurisdictions to prosecute the criminals nabbed by local law enforcement. Sinking some federal “teeth” into the problem would certainly reduce the effect of recalcitrance on the part of local officials.
Target has told its employees at the affected stores that they would have the opportunity to transfer to other locations within their respective areas.
This is lawlessness, plain and simple. While nearly a dozen states have passed laws imposing harsher penalties on these retail thieves (none of the four states listed above are included in that list), a coordinated and effective national effort is needed. Until such a program is implemented, the problem will persist. From an investment standpoint, we believe Target is trading at a 50% discount to its fair value.
Mo, 25 Sep 2023
Textiles, Apparel, & Luxury Goods
Jefferies downgrades Nike, sees student loan repayments impacting sales
We question the poll claiming 87% of student loan debt holders within their payback window will have trouble making those payments when they resume in October, but we do believe some discretionary companies will bear the brunt of the program’s resumption. Jefferies believes one of the most obvious targets will be footwear and athletic accessory maker Nike (NKE $91).
Then again, it’s not like the company hasn’t already been hammered. Floating around the $90-mark, Nike shares trade today where they traded in October 2019. In other words, your four-year investment would have had a negative real (inflation adjusted) return. Bulls may point to the fact that $90 puts the shares at a 50% discount to their November 2021 highs, but this is hardly a value play. Shares trade at a 28 multiple, and the forward P/E still clocks in at 25.
Jefferies downgraded Nike from Buy to Hold and lowered its price target from $140 to $100 per share. If they turn out to be right, a 10% gain would hardly be worth the risk.
The bullish calls on Nike over the past few years have revolved around the company’s growth in emerging markets, primarily China. With China and the US at interminable odds, we would cross through that bullet point. The strong US dollar poses a headwind, as it makes US goods more expensive for overseas buyers. Finally, the competitive landscape in the space is fierce, with Adidas, Under Armour, and a slew of newer entrants clawing away at market share. We agree with the Jefferies call and the analyst’s price target.
Th, 21 Sep 2023
Global Strategy: Middle East
Think a 5.5% US interest rate is high? Turkey just raised rates to 30%
We looked back on our previous comments on Turkey and found this quote from November 2021: “Despite the fact that his second five-year term, which will end in 2023, should make him ineligible from running again, any bets on who will still be the Turkish president in 2024?” We called it, as Recep Tayyip Erdogan recently won reelection to a third—and illegal—term as president. Perhaps it is the fabulous job he is doing with his country’s economy, such as the 60% annual inflation rate Turks are now facing.
To fight this nightmarish condition for the consumer, the Turkish central bank did something remarkable: it raised the benchmark rate from 25% to 30% at its latest meeting. The country has been trying to lure in foreign investment; maybe they can entice investors with their 18.79% ten-year government bond rate.
To say the economic situation in Turkey is dire is an understatement. Food costs have gone up 60% over the past year, while cafes, restaurants, and hotels have raised their prices by 83%. For Turks seeking a brief respite from domestic inflation by traveling abroad, more pain awaits. The lira has weakened substantially against the US dollar, losing one-third of its value this year alone. That makes exports from the Middle Eastern country cheaper for the world to buy, but that means little to the struggling consumer. At least their beloved leader is still in power.
Turkey is uninvestable and will remain so until Erdogan is gone. His latest power play is to hold Sweden’s NATO ambitions hostage until the European Union welcomes his country as a new member. That would be great for Turkey, not so much for the rest of the Union. The EU is already in the economic doldrums, and another big drag on the economy is the last thing it needs.
Th, 14 Sep 2023 Headlines
Arm opens at $56.10, 10% above IPO price; runs up to over $60/share
Tu, 12 Sep 2023
Biotechnology
Are cancer vaccines on the horizon? Moderna thinks so
It sounds like something straight out of science fiction, but Moderna (MRNA $105) is working to make it a reality. The $40 billion Cambridge, MA-based drug company has announced an agreement with German biotech firm Immatics NV (IMTX $12) to develop a line of cancer vaccines and therapies. The $1 billion small-cap will receive $120 million up front in a deal that could grow to nearly $2 billion, plus royalties.
For Moderna, the project represents the next stage in its revolutionary mRNA technology, which proved its efficacy during the pandemic. For its part, Immatics is engaged in the research and development of T-cell redirecting immunotherapies for the treatment of cancer. The collaboration will merge the two platforms with the goal of developing a line of novel oncology therapies.
Initially, cancer vaccines will be given to people who already have the disease, with the hopes that the body’s own immune system can be turned into a cancer-killing machine to prevent recurrence. By presenting tumor-specific antigens to the immune system, it will recognize them as a threat and destroy cells displaying the trait without harming healthy cells in the surrounding area. The ultimate goal would be the development of vaccines to be given to people with a high risk of the disease, but who are currently healthy. The combination of mRNA technology and the T-cell immunotherapy platform holds incredible promise in this area.
The agreement between these two firms is subject to antitrust clearance in the US. In the past, we would put the odds of approval at near 100%; in the current climate, however, we put those odds at around 80%.
While Immatics would be a purely speculative play on the part of investors (it brought in just $182 million in revenue last year, though $40 million did flow down as profit), Moderna looks extremely attractive at its current price. There has been an odd point of view that the company is overly reliant on its COVID vaccine for sales, which is extremely myopic. We believe many analysts cannot wrap their minds around the promise of mRNA technology and the potential growth it could bring to this company. Furthermore, Moderna operates with no debt on its books—a remarkable feat for a biotech. We would place a fair value of $210 on the shares.
Mo, 11 Sep 2023
Food Products
JM Smucker will buy iconic Twinkies brand for $5.6 billion
It seems hard to believe, but just over a decade ago there were no Twinkies to be found on any grocery shelves—well, except for really expired ones (actually, we don’t think they have an expiration date). The iconic little crème-filled delights, which began rolling off the Continental Baking Company assembly lines in 1930, went out of production in 2012 when Hostess Brands declared bankruptcy and liquidated. Sadly, Ding Dongs and Hostess CupCakes—that staple dessert in my brown lunch bag at Golden Oaks grade school, were also victims of the shutdown. As luck would have it, Private Equity Firm Apollo Global Management rode to the rescue, picking up Hostess for a song ($410 million), and taking the firm public once again in 2016.
Between 2016 and a few weeks ago, the market cap of Hostess (TWNK $33) rose from $450 million to around $3 billion. Then came the offer: JM Smucker (SJM $132), the famed sweets and jellies company which has been family run since 1897, would buy Hostess for $5.6 billion in cash and stock. Shareholders would receive $30 in cash and a fractional share of SJM for each TWNK share owned, which represented a whopping 54% premium to the recent stock price. The Wall Street Journal reported that Smucker beat out Penn Global Leaders Club member General Mills (GIS $66) with its winning bid.
The purchase caps an incredible comeback for the Twinkie, not to mention other Hostess brands such as the aforementioned Ding Dong and Hostess CupCakes, as well as Voortman brand cookies, Dolly Madison cakes, Donettes, HoHos, Zingers, and SnoBalls. The Lenexa, Kansas-based firm’s products will now join the likes of Folgers Coffee, Smucker’s jelly, Jiff peanut butter, and Milk Bone dog biscuits. Quite the coup.
We love the deal, but it will increase Smucker’s 60% debt-to-equity ratio substantially, which investors recognized by pounding the stock down 7% on the news. We continue to prefer General Mills in the space, and believe it remains at least 25% undervalued. In addition to its cereal line, General Mills owns such brands as Betty Crocker, Annie’s, Nature Valley, Pillsbury, Haagen-Dazs, and the Blue Buffalo line of premium pet food products.
Fr, 08 Sep 2023
Semiconductors & Equipment
The stage is set for the largest IPO in two years as Arm roadshow begins
If investors were excited about the recent Cava Group (CAVA $41) IPO (and they were), then they should really be excited about what is about to hit the market: shares of British semiconductor firm ARM Holdings. After all, one is a restaurant chain with enormous overhead and thin margins; the other designs and sells the most advanced semiconductors in the world.
Formerly trading under the symbol ARMH, the company was purchased and taken private by Masayoshi Son’s Softbank back in 2016 for $32 billion. Now, just over seven years later, the company is getting ready to public once again, this time under the symbol ARM and with a valuation north of $50 billion.
The firm will issue 95.5 million American depository receipts (ADRs), with each representing one ordinary share in a planned range of $47 to $51 apiece. Extrapolate that number out to the billion or so shares outstanding after the IPO, and we get a market cap in the $50 billion range. While that is just one-third the size of Intel (INTC $38) and nowhere near NVIDIA’s (NVDA $461) $1.1 trillion market cap, expect that fact to only amplify investor interest.
Arm Holdings does not make chips. Instead, it designs the cutting-edge processors which power nearly all smartphones in the world. It then licenses those designs to Intel, NVIDIA, AMD, Apple, Samsung, and virtually every other device-maker in the world, receiving royalties from every unit sold. And the designs aren’t limited to smartphones. It is estimated that nearly 70% of the world’s population uses an Arm-based device—from smartphones to servers to ordinary sensors. With the coming AI boom, the company’s reach will be nearly unprecedented. Expect to see the company trading on the NASDAQ as soon as this coming week.
We may be tempted to pick up shares of ARM out of the gate, but we expect demand to drive the price up as soon as the shares begin trading. If, for example, they shoot up to the $60s or higher, we would wait for the inevitable pullback to the $45 range. Expect this IPO to start a wave of other high-profile tech names going public—a welcome sign after two years of relative silence in the space.
Th, 07 Sep 2023
Global Strategy: East/Southeast Asia
Both Chinese export and import levels continue to fall as economic woes worsen
Ever since China became a member of the World Trade Organization in December 2001, countries—led by the United States—have been propping up the communist nation’s economy by rushing to buy the goods produced by its poorly paid but massive workforce. Now, following the pandemic and increasingly belligerent government words and actions, the fanciful growth rate envisaged by leader Xi and much of the American press is getting a reality check. Not only has the volume of exports dropped every month since April, but imports have also fallen every month this year as Chinese consumers face mounting economic challenges at home.
Goods leaving China fell by 8.78% in August from the prior year—a 9.5% drop with respect to the US—while imports fell by 7.34%. Factory activity in the country has been contracting since this past spring, and the youth jobless rate has been on such a steep incline that the government stopped reporting the figures to the public.
A major source of angst for consumers is the crumbling state of the domestic real estate market. The country’s largest homebuilder, Country Garden, just barely avoided default by making interest payments on outstanding bonds hours before the grace period ended. Investing in real estate projects has been the most favored method of building wealth for Chinese citizens, but as confidence in the sector continues to erode, new construction starts and property investments have plummeted. Millions of Chinese families have been boycotting payments on their mortgage loans due to unfinished projects and substandard construction. The government is trying to assuage borrowers by ordering state-owned banks to cut the interest rates on existing mortgages, but the effect has been minimal.
A telltale sign of who China blames for its economic problems—besides the United States, of course—is the country’s decision to skip the upcoming G20 summit in New Delhi. Russia, China’s new bestie, will also snub India by skipping the meeting. That is somewhat ironic since India has continued to enjoy a close trading relationship with Putin, to the chagrin of Washington. The weekend meeting will give Biden another chance to solidify America’s support of increased trade with India. If Prime Minister Narendra Modi can actually modernize India’s archaic business structure, that country could be the biggest threat to China’s growth rate going forward.
Remember when the “must-have” international investment was a BRICs vehicle? We do. Brazil is once again being led by far-leftist Lula after he spent time in the pokey. He has invited Chinese warships to dock at Brazilian ports. Russia is a global pariah led by a madman. China is a communist nation hell-bent on ruling the world. That leaves one “BRIC” in the wall intact: India. Yes, enormous challenges remain, but the country is a democracy, and the government will eventually straighten out its byzantine business structure. The largest ETF providing exposure to the Indian market is the iShares MSCI India ETF (INDA $44). The fund has rallied some 15% since March, while the iShares MSCI China ETF (MCHI $44) has fallen nearly 22% since the middle of January. Investors may not recognize many names among the 122 companies in the India ETF, but we expect that to change over the coming decade.
Tu, 05 Sep 2023
Global Exchanges & Indexes
Rebalancing season: Airbnb and Blackstone added to the S&P 500
Both travel services company Airbnb (ABNB $140) and alternative asset manager Blackstone (BX $108) rallied at the start of the week on news that they would be replacing Newell Brands (NWL $11) and Lincoln National (LNC $26) in the S&P 500 index. Meanwhile, troubled pharmacy retailer Walgreens (WBA $23), which just fired CEO Rosalind Brewer, will be replaced in the S&P 100 by ag equipment maker Deere (DE $417). The benchmark put it politely when it said the changes were taking place to “better represent its market cap range,” which simply means the deletions had lost too much of their size to remain viable members.
Moving down in cap size, Morningstar (MORN $246), Ally Financial (ALLY $29), Vail Resorts (MTN $243), and Weatherford International (WFRD $94) are some of the names we like which will be entering the S&P MidCap 400, replacing such companies as Energizer (ENR $36), Xerox (XRX $17), JetBlue Airways (JBLU $6), and Foot Locker (FL $19)—four names struggling for quite different reasons. JetBlue, for example, has been in a fierce battle with the Department of Justice and FTC over its planned acquisition of Spirit Airlines (SAVE $16). It didn’t help when court documents revealed that JetBlue might raise airfares on certain Spirit routes by as much as 40%. At $2 billion in size, the airline was knocked down to the S&P SmallCap 600.
All of this reshuffling will be concluded by market open on Monday the 18th of September.
We recently took profits on our Airbnb position at a level higher than where it is currently trading (though we may revisit a purchase if it falls below $120/share). Despite the removal of their CEO, who oversaw a 58% decline in the company’s size, we aren’t ready to touch Walgreens—mainly because a successor hasn’t been chosen yet, and CVS looks like a much better value. Vail Resorts is a name we have owned in the past, and it is still trading some 55% off of its high. The company also has a nice 3.62% dividend yield. From a cap size, we strongly favor the beaten-down small caps for the remainder of the year, as represented by our position in the Value Line Small Cap Opportunities Fund (VLEIX $51) and the Invesco S&P SmallCap 600 Revenue ETF (RWJ $39).
Th, 28 Sep 2023
Aerospace & Defense
Lockheed Martin lands two big F-35 deals with Romania, Czech Republic
Two former Warsaw Pact nations, now both staunch US allies and members of NATO, have signed agreements to purchase advanced Lockheed Martin (LMT $411) F-35 Lightning II aircraft in an overhaul of their respect air forces. Romania will purchase 32 of the fifth-generation fighters for $6.5 billion, while the Czech Republic has approved the purchase of 24 F-35s for around $4.5 billion.
Romanian Defense Minister Angel Tîlvăr said the purchase will give the Romanian Air Force state-of-the-art capabilities “in the security architecture on NATO’s eastern flank and in the Black Sea region.” Following the purchase of these two 16-aircraft squadrons, the country also said it may pursue an acquisition of a third squadron.
As for the Czech Republic, the deal was a bit more controversial. The Czech Air Force’s top fighter is currently the Gripen, which it leases from Swedish aerospace and defense firm Saab AB (SAABY $27). After months of lobbying by the defense ministry, the government of Petr Pavel agreed to ditch renewing the lease—set to expire in 2027—in favor of the purchase, which will include simulators, pilot training, and a weapons package. Prime Minister Petr Fiala said the deal “is an effective solution” which will “solve the future of our tactical air force for decades to come, in contrast to (continuing to lease) older generations of fighter aircraft.” Prague is planning to rebuild its Caslav Air Base to accommodate the new fleet.
The F-35 is rapidly becoming the cutting-edge fighter of choice among Eastern European countries, with production of a previous order from Poland ramping up this year at Lockheed’s Fort Worth, Texas assembly lines.
We believe Lockheed Martin is the strongest player in the global aerospace and defense industry, not just within the United States. Boeing (BA $193) continues to prove it never should have been allowed to buy McDonnell Douglas, a fierce competitor in the space until the acquisition, as the company can’t seem to stop mucking up its military and civilian operations on both the aircraft and space sides of its business. We also believe that investors are underestimating Lockheed’s leadership role in the industry going forward. We would place a fair value on LMT shares at $550. Consider the recurring income stream from maintaining all of those F-35s around the world over the next several decades, and then consider that this is just one component of the company’s massive array of space and defense products and services.
We, 27 Sep 2023
Multiline Retail
Target announces the closure of nine stores in crime-ridden areas
It is a horrendous problem and a sad testament on the current state of American society. Organized crime has become so rampant at bricks-and-mortar stores that major American retailer Target (TGT $109) has announced the closure of nine locations in four states to protect their employees from physical harm. The affected stores are in New York City, Seattle, San Francisco, and Portland.
Target, which operates at 1,950 locations across the country, becomes the first retailer to specifically blame crime for the shuttering of stores. While many management teams have shied away from discussing the problem during quarterly conference calls, CEO Brian Cornell has been shining a spotlight on this disgraceful situation. While Target earned nearly $3 billion in profit during the most recent fiscal year, Cornell said he expects the company to take a $500 million hit this year due to theft.
The industry is pushing Congress to pass the Combating Organized Retail Crime Act, which would create an organization within the Department of Homeland Security to better align federal, state, and local law enforcement agencies engaged in the fight. It would also impose harsher penalties on offenders, and force online marketplaces to step up their vetting of vendors to help assure stolen goods stay off the sites. One major challenge has been the lack of willingness on the part of certain jurisdictions to prosecute the criminals nabbed by local law enforcement. Sinking some federal “teeth” into the problem would certainly reduce the effect of recalcitrance on the part of local officials.
Target has told its employees at the affected stores that they would have the opportunity to transfer to other locations within their respective areas.
This is lawlessness, plain and simple. While nearly a dozen states have passed laws imposing harsher penalties on these retail thieves (none of the four states listed above are included in that list), a coordinated and effective national effort is needed. Until such a program is implemented, the problem will persist. From an investment standpoint, we believe Target is trading at a 50% discount to its fair value.
Mo, 25 Sep 2023
Textiles, Apparel, & Luxury Goods
Jefferies downgrades Nike, sees student loan repayments impacting sales
We question the poll claiming 87% of student loan debt holders within their payback window will have trouble making those payments when they resume in October, but we do believe some discretionary companies will bear the brunt of the program’s resumption. Jefferies believes one of the most obvious targets will be footwear and athletic accessory maker Nike (NKE $91).
Then again, it’s not like the company hasn’t already been hammered. Floating around the $90-mark, Nike shares trade today where they traded in October 2019. In other words, your four-year investment would have had a negative real (inflation adjusted) return. Bulls may point to the fact that $90 puts the shares at a 50% discount to their November 2021 highs, but this is hardly a value play. Shares trade at a 28 multiple, and the forward P/E still clocks in at 25.
Jefferies downgraded Nike from Buy to Hold and lowered its price target from $140 to $100 per share. If they turn out to be right, a 10% gain would hardly be worth the risk.
The bullish calls on Nike over the past few years have revolved around the company’s growth in emerging markets, primarily China. With China and the US at interminable odds, we would cross through that bullet point. The strong US dollar poses a headwind, as it makes US goods more expensive for overseas buyers. Finally, the competitive landscape in the space is fierce, with Adidas, Under Armour, and a slew of newer entrants clawing away at market share. We agree with the Jefferies call and the analyst’s price target.
Th, 21 Sep 2023
Global Strategy: Middle East
Think a 5.5% US interest rate is high? Turkey just raised rates to 30%
We looked back on our previous comments on Turkey and found this quote from November 2021: “Despite the fact that his second five-year term, which will end in 2023, should make him ineligible from running again, any bets on who will still be the Turkish president in 2024?” We called it, as Recep Tayyip Erdogan recently won reelection to a third—and illegal—term as president. Perhaps it is the fabulous job he is doing with his country’s economy, such as the 60% annual inflation rate Turks are now facing.
To fight this nightmarish condition for the consumer, the Turkish central bank did something remarkable: it raised the benchmark rate from 25% to 30% at its latest meeting. The country has been trying to lure in foreign investment; maybe they can entice investors with their 18.79% ten-year government bond rate.
To say the economic situation in Turkey is dire is an understatement. Food costs have gone up 60% over the past year, while cafes, restaurants, and hotels have raised their prices by 83%. For Turks seeking a brief respite from domestic inflation by traveling abroad, more pain awaits. The lira has weakened substantially against the US dollar, losing one-third of its value this year alone. That makes exports from the Middle Eastern country cheaper for the world to buy, but that means little to the struggling consumer. At least their beloved leader is still in power.
Turkey is uninvestable and will remain so until Erdogan is gone. His latest power play is to hold Sweden’s NATO ambitions hostage until the European Union welcomes his country as a new member. That would be great for Turkey, not so much for the rest of the Union. The EU is already in the economic doldrums, and another big drag on the economy is the last thing it needs.
Th, 14 Sep 2023 Headlines
Arm opens at $56.10, 10% above IPO price; runs up to over $60/share
Tu, 12 Sep 2023
Biotechnology
Are cancer vaccines on the horizon? Moderna thinks so
It sounds like something straight out of science fiction, but Moderna (MRNA $105) is working to make it a reality. The $40 billion Cambridge, MA-based drug company has announced an agreement with German biotech firm Immatics NV (IMTX $12) to develop a line of cancer vaccines and therapies. The $1 billion small-cap will receive $120 million up front in a deal that could grow to nearly $2 billion, plus royalties.
For Moderna, the project represents the next stage in its revolutionary mRNA technology, which proved its efficacy during the pandemic. For its part, Immatics is engaged in the research and development of T-cell redirecting immunotherapies for the treatment of cancer. The collaboration will merge the two platforms with the goal of developing a line of novel oncology therapies.
Initially, cancer vaccines will be given to people who already have the disease, with the hopes that the body’s own immune system can be turned into a cancer-killing machine to prevent recurrence. By presenting tumor-specific antigens to the immune system, it will recognize them as a threat and destroy cells displaying the trait without harming healthy cells in the surrounding area. The ultimate goal would be the development of vaccines to be given to people with a high risk of the disease, but who are currently healthy. The combination of mRNA technology and the T-cell immunotherapy platform holds incredible promise in this area.
The agreement between these two firms is subject to antitrust clearance in the US. In the past, we would put the odds of approval at near 100%; in the current climate, however, we put those odds at around 80%.
While Immatics would be a purely speculative play on the part of investors (it brought in just $182 million in revenue last year, though $40 million did flow down as profit), Moderna looks extremely attractive at its current price. There has been an odd point of view that the company is overly reliant on its COVID vaccine for sales, which is extremely myopic. We believe many analysts cannot wrap their minds around the promise of mRNA technology and the potential growth it could bring to this company. Furthermore, Moderna operates with no debt on its books—a remarkable feat for a biotech. We would place a fair value of $210 on the shares.
Mo, 11 Sep 2023
Food Products
JM Smucker will buy iconic Twinkies brand for $5.6 billion
It seems hard to believe, but just over a decade ago there were no Twinkies to be found on any grocery shelves—well, except for really expired ones (actually, we don’t think they have an expiration date). The iconic little crème-filled delights, which began rolling off the Continental Baking Company assembly lines in 1930, went out of production in 2012 when Hostess Brands declared bankruptcy and liquidated. Sadly, Ding Dongs and Hostess CupCakes—that staple dessert in my brown lunch bag at Golden Oaks grade school, were also victims of the shutdown. As luck would have it, Private Equity Firm Apollo Global Management rode to the rescue, picking up Hostess for a song ($410 million), and taking the firm public once again in 2016.
Between 2016 and a few weeks ago, the market cap of Hostess (TWNK $33) rose from $450 million to around $3 billion. Then came the offer: JM Smucker (SJM $132), the famed sweets and jellies company which has been family run since 1897, would buy Hostess for $5.6 billion in cash and stock. Shareholders would receive $30 in cash and a fractional share of SJM for each TWNK share owned, which represented a whopping 54% premium to the recent stock price. The Wall Street Journal reported that Smucker beat out Penn Global Leaders Club member General Mills (GIS $66) with its winning bid.
The purchase caps an incredible comeback for the Twinkie, not to mention other Hostess brands such as the aforementioned Ding Dong and Hostess CupCakes, as well as Voortman brand cookies, Dolly Madison cakes, Donettes, HoHos, Zingers, and SnoBalls. The Lenexa, Kansas-based firm’s products will now join the likes of Folgers Coffee, Smucker’s jelly, Jiff peanut butter, and Milk Bone dog biscuits. Quite the coup.
We love the deal, but it will increase Smucker’s 60% debt-to-equity ratio substantially, which investors recognized by pounding the stock down 7% on the news. We continue to prefer General Mills in the space, and believe it remains at least 25% undervalued. In addition to its cereal line, General Mills owns such brands as Betty Crocker, Annie’s, Nature Valley, Pillsbury, Haagen-Dazs, and the Blue Buffalo line of premium pet food products.
Fr, 08 Sep 2023
Semiconductors & Equipment
The stage is set for the largest IPO in two years as Arm roadshow begins
If investors were excited about the recent Cava Group (CAVA $41) IPO (and they were), then they should really be excited about what is about to hit the market: shares of British semiconductor firm ARM Holdings. After all, one is a restaurant chain with enormous overhead and thin margins; the other designs and sells the most advanced semiconductors in the world.
Formerly trading under the symbol ARMH, the company was purchased and taken private by Masayoshi Son’s Softbank back in 2016 for $32 billion. Now, just over seven years later, the company is getting ready to public once again, this time under the symbol ARM and with a valuation north of $50 billion.
The firm will issue 95.5 million American depository receipts (ADRs), with each representing one ordinary share in a planned range of $47 to $51 apiece. Extrapolate that number out to the billion or so shares outstanding after the IPO, and we get a market cap in the $50 billion range. While that is just one-third the size of Intel (INTC $38) and nowhere near NVIDIA’s (NVDA $461) $1.1 trillion market cap, expect that fact to only amplify investor interest.
Arm Holdings does not make chips. Instead, it designs the cutting-edge processors which power nearly all smartphones in the world. It then licenses those designs to Intel, NVIDIA, AMD, Apple, Samsung, and virtually every other device-maker in the world, receiving royalties from every unit sold. And the designs aren’t limited to smartphones. It is estimated that nearly 70% of the world’s population uses an Arm-based device—from smartphones to servers to ordinary sensors. With the coming AI boom, the company’s reach will be nearly unprecedented. Expect to see the company trading on the NASDAQ as soon as this coming week.
We may be tempted to pick up shares of ARM out of the gate, but we expect demand to drive the price up as soon as the shares begin trading. If, for example, they shoot up to the $60s or higher, we would wait for the inevitable pullback to the $45 range. Expect this IPO to start a wave of other high-profile tech names going public—a welcome sign after two years of relative silence in the space.
Th, 07 Sep 2023
Global Strategy: East/Southeast Asia
Both Chinese export and import levels continue to fall as economic woes worsen
Ever since China became a member of the World Trade Organization in December 2001, countries—led by the United States—have been propping up the communist nation’s economy by rushing to buy the goods produced by its poorly paid but massive workforce. Now, following the pandemic and increasingly belligerent government words and actions, the fanciful growth rate envisaged by leader Xi and much of the American press is getting a reality check. Not only has the volume of exports dropped every month since April, but imports have also fallen every month this year as Chinese consumers face mounting economic challenges at home.
Goods leaving China fell by 8.78% in August from the prior year—a 9.5% drop with respect to the US—while imports fell by 7.34%. Factory activity in the country has been contracting since this past spring, and the youth jobless rate has been on such a steep incline that the government stopped reporting the figures to the public.
A major source of angst for consumers is the crumbling state of the domestic real estate market. The country’s largest homebuilder, Country Garden, just barely avoided default by making interest payments on outstanding bonds hours before the grace period ended. Investing in real estate projects has been the most favored method of building wealth for Chinese citizens, but as confidence in the sector continues to erode, new construction starts and property investments have plummeted. Millions of Chinese families have been boycotting payments on their mortgage loans due to unfinished projects and substandard construction. The government is trying to assuage borrowers by ordering state-owned banks to cut the interest rates on existing mortgages, but the effect has been minimal.
A telltale sign of who China blames for its economic problems—besides the United States, of course—is the country’s decision to skip the upcoming G20 summit in New Delhi. Russia, China’s new bestie, will also snub India by skipping the meeting. That is somewhat ironic since India has continued to enjoy a close trading relationship with Putin, to the chagrin of Washington. The weekend meeting will give Biden another chance to solidify America’s support of increased trade with India. If Prime Minister Narendra Modi can actually modernize India’s archaic business structure, that country could be the biggest threat to China’s growth rate going forward.
Remember when the “must-have” international investment was a BRICs vehicle? We do. Brazil is once again being led by far-leftist Lula after he spent time in the pokey. He has invited Chinese warships to dock at Brazilian ports. Russia is a global pariah led by a madman. China is a communist nation hell-bent on ruling the world. That leaves one “BRIC” in the wall intact: India. Yes, enormous challenges remain, but the country is a democracy, and the government will eventually straighten out its byzantine business structure. The largest ETF providing exposure to the Indian market is the iShares MSCI India ETF (INDA $44). The fund has rallied some 15% since March, while the iShares MSCI China ETF (MCHI $44) has fallen nearly 22% since the middle of January. Investors may not recognize many names among the 122 companies in the India ETF, but we expect that to change over the coming decade.
Tu, 05 Sep 2023
Global Exchanges & Indexes
Rebalancing season: Airbnb and Blackstone added to the S&P 500
Both travel services company Airbnb (ABNB $140) and alternative asset manager Blackstone (BX $108) rallied at the start of the week on news that they would be replacing Newell Brands (NWL $11) and Lincoln National (LNC $26) in the S&P 500 index. Meanwhile, troubled pharmacy retailer Walgreens (WBA $23), which just fired CEO Rosalind Brewer, will be replaced in the S&P 100 by ag equipment maker Deere (DE $417). The benchmark put it politely when it said the changes were taking place to “better represent its market cap range,” which simply means the deletions had lost too much of their size to remain viable members.
Moving down in cap size, Morningstar (MORN $246), Ally Financial (ALLY $29), Vail Resorts (MTN $243), and Weatherford International (WFRD $94) are some of the names we like which will be entering the S&P MidCap 400, replacing such companies as Energizer (ENR $36), Xerox (XRX $17), JetBlue Airways (JBLU $6), and Foot Locker (FL $19)—four names struggling for quite different reasons. JetBlue, for example, has been in a fierce battle with the Department of Justice and FTC over its planned acquisition of Spirit Airlines (SAVE $16). It didn’t help when court documents revealed that JetBlue might raise airfares on certain Spirit routes by as much as 40%. At $2 billion in size, the airline was knocked down to the S&P SmallCap 600.
All of this reshuffling will be concluded by market open on Monday the 18th of September.
We recently took profits on our Airbnb position at a level higher than where it is currently trading (though we may revisit a purchase if it falls below $120/share). Despite the removal of their CEO, who oversaw a 58% decline in the company’s size, we aren’t ready to touch Walgreens—mainly because a successor hasn’t been chosen yet, and CVS looks like a much better value. Vail Resorts is a name we have owned in the past, and it is still trading some 55% off of its high. The company also has a nice 3.62% dividend yield. From a cap size, we strongly favor the beaten-down small caps for the remainder of the year, as represented by our position in the Value Line Small Cap Opportunities Fund (VLEIX $51) and the Invesco S&P SmallCap 600 Revenue ETF (RWJ $39).
Headlines for the Month of Aug 2023
Tu, 29 Aug 2023
Specialty Retail
Best Buy beats, sees consumer demand for electronics troughing this year
We probably have more old investor notes on Best Buy (BBY $78) than just about any other company. That may seem strange, given its relatively small size and the industry it’s in, but we have always had an affinity for the consumer retailer. While we don’t currently own the $16 billion firm in any strategy right now, it does look compelling at $78 per share.
Best Buy released a good-looking Q2 earnings report early in the week, beating the Street’s expectations for both revenue and net income. Revenue came in at $9.58 billion versus the $9.52 billion expected, and the company posted earnings of $1.22 per share versus the $1.06 projected. CEO Corie Barry, at the helm for four years now, said that the industry still faces headwinds due to the “pull-forward in demand” in recent years (due to the pandemic), but that this year should reflect the low point. For the year, the company expects to earn around $6 to $6.40 from roughly $44 billion in sales.
Despite being the one remaining big-box electronics retailer left standing (remember Silo and Circuit City?), Best Buy has not been standing still. We like the company’s paid membership programs as a source of recurring revenue and a way to build stronger bonds with customers, and the ongoing redesign of stores to reflect the increase in digital sales. Roughly one-third of sales are now made online, and the physical stores are morphing into a mix of showroom, fulfillment center, and service area (Best Buy bought Geek Squad back in 2002).
Finally, Best Buy Health looks intriguing, but it is way too early to know if the program will be a success. The company has been forming alliances with health care providers to supply hardware and installation services to meet the medical needs of patients. Healthcare devices for remote monitoring are a key piece of the puzzle. If this unit can become profitable, it will be yet another reason to own the shares.
Best Buy has long attracted the attention of short sellers, but the firm continues to defy the haters. With its solid balance sheet, low multiple, and strong leader at the helm, we believe the shares are worth between $90 and $100.
Mo, 28 Aug 2023
Electric Utilities
Maui County sued Hawaiian Electric for the deadly wildfires; the utility is firing back
When I first got in the business, I recall making phone calls to clients or prospective clients about various investments. One broker I would often make these calls with began his greeting in a way that would make me put my hand over my eyes and shake my head: “Aloha, Mr./Ms. Smith! You may be wondering why I greeted you that way….” I still wince when I think of it. He was pushing shares of Hawaiian Electric (HE $13), provider of electricity for the five islands.
In addition to hoping the utility would conjure up images of the tropics in their minds, this broker sold the concept of owning a strong, regulated utility company with a fat (around 7% at the time), safe dividend yield. Who could argue with that logic? Unfortunately, nothing is certain in the world of investments. Case in point: Consider the breakup of the stalwart Bell System in the early 1980s and the tumult which ensued.
As for Hawaiian Electric, it had been a relatively stable performer for decades, with a rock-solid dividend. All of that changed virtually overnight with the tragic Maui wildfires. Before Maui County had even concluded its own investigation into the disaster, it sued the utility for negligence, claiming that power should have been shut down well before it was. In short, it blamed the company for the deaths which ensued. In a matter of days, HE’s share price dropped from $40 to $15; by Friday the 25th, shares had dropped to $9.06—their lowest level since 1985 and off 76% since the start of the year. The company immediately suspended its dividend, and a Forbes article opined that a Chapter 11 bankruptcy was “the most plausible path forward.”
By the following Monday, news hit that Hawaiian Electric did, in fact, “de-energize” its power lines in the region more than six hours before the fire which destroyed the town of Lahaina had begun. Furthermore, an earlier fire caused by a downed line had been quickly extinguished by the local fire department. The company turned the blame back to the county, and HE shares responded with a 40% surge within seconds of the open.
It's too early to predict what will ultimately happen in the courts, but the tragic incident should serve as a reminder to investors that even seemingly conservative investments can be hammered by unexpected events. Then again, anyone who had a large portion of their portfolios in the “safe” bond market in 2022 had already learned that lesson.
Utilities are the worst-performing sector over the past twelve months, off some 14%. When interest rates are relatively high, conservative investors tend to migrate out of utilities and into bonds for their income stream. However, virtually every portfolio should have at least a small portion allocated to this sector for proper diversification. We own several utility companies in the Strategic Income Portfolio and the Penn Global Leaders Club, and a 3% position in XLU, the Utilities Select Sector SPDR, within the Dynamic Growth Strategy.
Sa, 26 Aug 2023
Market Pulse
A bumpy five days marked by higher mortgage rates and Powell’s Jackson Hole comments
The S&P 500 vacillated between positive and negative returns this week, with each day closing in a different direction. Between mortgage rates hitting levels not seen since December 2000 and angst over what Fed Chair Jerome Powell would say at the Jackson Hole Symposium on Friday, investors were lucky to end the week relatively unscathed.
Tech stocks started out the week on fire after Softbank announced semiconductor giant Arm Holdings, formerly holding the symbol ARMH, would go public once again via an IPO. This time it will carry the symbol ARM. This company designs the architecture of chips which are found in nearly every single smartphone. While the exact valuation SoftBank will be seeking is not yet known, expect the company to open with a market cap of between $60 billion and $70 billion; also expect a flurry of IPO activity following this bombshell announcement. The NASDAQ finished up over 2% on the week, with most of the gains coming on Monday.
Boeing (BA $223) and Disney (DIS $83) held the Dow Jones Industrial Average in the red this week, with the latter dropping to price levels not seen since 2014. We have discussed ad nauseum what we think of both management teams. The small-cap Russell 2000 benchmark also finished in the red, while the S&P 500 managed to gain 82 basis points by Friday’s close.
As usual, investors didn’t know what to make of Powell’s presser, this one occurring at the Kansas City Fed’s Jackson Hole Economic Symposium. While they didn’t like the “we are not done yet (fighting inflation)” comments, his overall speech was relatively dovish. We continue to believe the Fed is done raising rates, but do not believe they will be in any hurry to lower rates in 2024. According to Mortgage News Daily, the average 30-year mortgage rate hit 7.48% this week before settling in around 7.23% on Friday. Oil closed Friday down about 1.66%, or $80.05 per barrel.
Next week’s big potential market movers will be the Case-Shiller Home Price Index on Tuesday, Salesforce’s results on Wednesday, and the August jobs report on Friday. Economists are looking for an additional 172,500 jobs for the month, down from 187,000 in July.
Fr, 25 Aug 2023
Electric Utilities
More than three decades later, a new nuclear power plant enters operation
It was seven years late and $17 billion over budget, but the first built-from-scratch domestic nuclear power plant in over thirty years is up and running. Georgia Power’s Plant Vogtle Unit 3, southeast of Augusta, will generate 1,100 megawatts of electricity, or enough to power 500,000 homes and businesses. Vogtle Unit 4 is also nearing completion, with expectations for a March 2024 production date.
Construction on the new plant began back in 2009 and has been marred by setbacks, including the 2017 bankruptcy of plant maker Westinghouse. The delays have taken a toll on Georgia Power’s parent company, utility giant Southern Co. (SO $68). That said, SO has outperformed the industry this year, down just 1.75% as compared to the Utilities Select Sector SPDR’s (XLU $64) 8.3% loss.
As for the future of nuclear power, while there are around 100 reactors planned or on order and another 300 proposed around the world, none are in the US. However, while there may not be any more of these massive Gen 3+ reactors built on US soil, the industry is betting on advanced, small modular reactors (SMR) known as Gen 4 units to carry it into the future. Oregon-based NuScale Power (SMR $6) has an agreement to build a first-of-its-kind modular reactor in Idaho, set to begin commercial operation by the end of the decade. Privately held TerraPower is working on another new reactor design, known as Natrium, which it is testing at a retired coal plant in Kemmerer, Wyoming.
While we expect Vogtle Units 3 and 4 to be the last of the traditional nuclear power plants built in the US, and the regulatory hurdles for the Gen 4 plants will be high, we still believe the industry has a critical role in the future of “green” energy in the country.
While an investment in SMR would be highly speculative, the Global X Uranium ETF (URA $23) is an interesting way to play the uranium-mining angle. It holds 49 of the world’s top uranium miners, with a 24% position in Cameco Corp (CCJ $36), arguably the world’s largest producer of the heavy metal. From a utilities standpoint, two companies with the largest exposure to nuclear power generation are Southern Co. and Entergy Corp (ETR $95), each with a 4.5% dividend yield.
Th, 24 Aug 2023
Metals & Mining
US Steel wants to be acquired; the steelworkers union wants to select the winning bidder
Sadly, the US steelmaking industry isn’t what it used to be. Take US Steel (X $31), which was trading around $200 per share in 2008 and bottomed out at $7.21 per share less than a decade later. Competition has become so keen in the industry—China now accounts for nearly half of the world’s output—that the storied US manufacturer, founded in 1901 by a group of potentates including Andrew Carnegie and J.P. Morgan, is actively searching for suitors.
This strategic review was fomented by multiple unsolicited bids, most notably Cleveland-Cliffs’ (CLF $15) $7.3 billion takeover offer; a proposal which was quickly rebuffed. All of this acquisition talk quickly drove up the share price of X from $22.50 to $32 in the matter of a week, but one other consideration needs to be factored in: the role of the United Steelworkers union (USW).
Esmark, an industrial conglomerate which made an all-cash bid for US Steel at a higher offering price than CLF, has already pulled its offer, citing the union’s support for the original bidder. An agreement between the company and the union specifies that if the USW supports one specific bidder, another company’s offer cannot be accepted unless the board of directors deems it superior. Furthermore, the buyer must either assume the existing labor contract or forge a new deal with the union before a transaction can take place. Needless to say, US Steel disagrees with this wide interpretation of the rules.
Yet another concern is the draconian FTC, headed by the anti-business activist Lina Khan. It is all but given that the agency would file lawsuits to stop a merger between two competing US steel companies—even if it meant a stronger hand against Chinese manufacturers. It appears that a deal will eventually get done, but the road ahead will be anything but smooth.
Investors who see value in this beaten-down industry (X has a multiple of 6) need to remember just how much the bottom line is affected by commodity prices, higher energy costs, competition from China, and economic conditions. As for US Steel, it is trading at or above fair market value due to the bidding war—in other words, an ultimate sale has already been baked into the price. As for the competitors mentioned, we don’t see any undervalued gems begging for investors to pounce. If we had to hold a position in the industry, it would be Japanese small-cap producer Yamato Kogyo Co Ltd (YMTKF $32, P/E ratio 4.4), which has major markets in Japan, South Korea, and Thailand. Consider any investment in the industry higher risk.
Tu, 22 Aug 2023
Leisure Equipment, Products, & Facilities
Dick’s Sporting Goods plunges by nearly 25%; it still doesn’t look cheap
It’s called “shrink,” but that’s just a politically correct way of saying theft. The condition was one of several reasons Dick’s Sporting Goods (DKS $112) gave for a disappointing earnings report; a report which caused shares to sink by nearly one-fourth in a matter of minutes.
On sales of $3.22 billion (analysts had been predicting $3.24B), the company earned $2.82 per share in the second quarter of the year. That is about 35% lighter than the Street expected. Management also reduced its full-year outlook, citing the resumption of student loan payments, a choppy economic environment, and the theft issue. Not showing up in this quarter’s results, the company will also have to shell out around $20 million in severance packets to recently laid off employees.
From our perspective, the biggest issues facing the retailer are increased competition in the space, a poor management team, discretionary cutbacks by consumers, and the lingering theft issue which few retailers have the courage to take on. And none of those issues are going to dissipate soon.
Consider the firm’s operating margin—the proportion of revenue left over after paying the variable costs of production. That measure of efficiency went from 16.5% in 2021 to 11.8% in 2022, and we expect the number to continue dropping as pricing power further erodes. Key vendors like Adidas and Nike have been strongly developing their own direct-to-consumer channels, reducing their dependence on third-party retailers such as Dick’s. Additionally, we see inflation continuing to constrict margins, as it is becoming more difficult to pass along higher prices on the type of elastic goods sold at the retailer. It may seem as though investors overreacted to this latest earnings report; considering the challenges ahead, however, we don’t think so.
With well-run competitors like Scheels (privately held) and Academy Sports and Outdoors (ASO $53) increasing market share, we see no reason to buy DKS on this hefty pullback; nor do we see any unique value proposition being presented by management.
Mo, 21 Aug 2023
Media & Entertainment
Iger’s tone-deaf response to falling subs: raise prices across the board
We had high hopes for entertainment powerhouse Disney (DIS $86) when the board finally gave Chapek the boot (shortly after extending his contract) and brought back former CEO Iger. We should have remembered our first thought after reading his autobiography: what an arrogant SOB. Indeed, Iger’s “I’m the greatest,” bull in a china shop approach has only wreaked more havoc on the company.
His latest misstep, fresh off the heels of ticking off Hollywood during a CNBC interview with David Faber, comes in his response to floundering Disney+ subscriptions. After giving mixed quarterly results for Q2, which included flatlining subscriber growth for the company’s streaming service, Iger announced that the ad-free version of Disney+ would now cost faithful subscribers 27% more. In addition to the $13.99 per month fee (up from $10.99), the company’s no-ad Hulu streaming service would jump 20%, from $14.99 to $17.99. Disney’s ad-supported service will remain $7.99 per month, but Iger even stepped in it with regards to that option. When pressed on the rate hikes, he flippantly indicated he would be just fine with subscribers dumping the ad model for the lower priced alternative, as the company would “make more via the ads.” Tone deaf.
An appropriate answer for slowing growth is never “let’s milk our faithful customers more for their current products and services,” but Iger doesn’t get it. While Disney’s streaming service has been a gamble from the start, the company always had its money-printing parks to serve as the cash cow, but even that is changing. Over the Independence Day weekend, wait times for rides at Disney’s US parks were the lowest they have been in over a decade—and no, that is not due to improvements in efficiency. It may, however, have something to do with the multiple price hikes implemented at the parks this year. Try this on for size: A one-person, one-day Park Hopper ticket for an adult (ten years or older) now costs up to $268.38. Happy sticking to one park for the day? Look to pay as much as $189.
We will always love the Disney experience, but something tells us Walt would clean house in the C-suite were he alive today. And who can blame him?
The first step to solving a problem is admitting you have one in the first place, and then accepting responsibility for it. Iger may say the right things (well, actually, not lately), but his arrogance will keep him from doing the right things. Until there are massive changes at the top, we don’t see owning this company in any of the Penn strategies.
We, 09 Aug 2023
Global Strategy: East/Southeast Asia
China’s economy continues to contract
As most of the developed world continues to grapple with inflation, China has quite a different challenge: fewer people—both at home and abroad—are buying Chinese goods, causing a serious case of deflation within the country.
China’s exports to the rest of the world fell 14.5% in July from the previous year, representing the sharpest downturn since February 2020—the earliest days of the pandemic. At home, real estate values are plunging, causing the average Chinese consumer to pull back on spending. Not only did consumer prices fall in July, producer prices fell for a tenth straight month, contracting 4.4% in July from the prior year.
As is always the case in a controlled economy, the Chinese Communist Party believes it can ride to the rescue with more government action. The People’s Bank of China is expected to reduce rates in an effort to spur economic activity, and the CCP has announced a new round of massive government spending. But even if it works at home (it won’t), how is that going to help reverse the contraction in exports? Chinese goods shipments to the US fell some 23% in July from the prior year, and shipments to the EU dropped around 20%.
After President for Life Xi announced his plans for global economic dominance while reiterating his support for Russia’s Putin, the Western world began scrambling to find alternate suppliers of goods to reduce reliance on the communist nation. While China’s exports to Russia have mushroomed since Putin’s invasion of Ukraine, that amounts to a drop in the bucket compared to the contracts which have been lost due to supply chain realignment. And China’s new exertion of control over quasi-private firms in the country will only exacerbate the problem. The only solution is a humble mea culpa by the regime and a distancing from Russia with respect to Ukraine, and there is zero chance that either of those actions will take place.
Chinese companies may seem appealing on the recent pull back, but investors should steer clear of the country for the international portion of their portfolios. Instead, consider India, Vietnam, Malaysia, and a host of other countries which are directly benefitting from the corporate migration away from China.
Tu, 08 Aug 2023
Beverages, Tobacco, & Cannabis
Cannabis company Tilray buying eight beer and beverage brands from Bud
It is no secret that our favorite Canadian cannabis company is Tilray (TLRY $2), run by the highly skilled beverage industry veteran Irwin Simon, founder of Hain Celestial Group. Despite the industry falling off the proverbial cliff over the past few years (Tilray shares topped out at $38 in February 2021), we still believe that a handful of players are destined to excel once they can legally operate in the US. In the meantime, Simon has been pursuing a bold path outside of the weed market—exemplified by this week’s news of a rather major acquisition.
Tilray has announced the purchase of eight beer and beverage brands from troubled brewer AB/InBev (BUD $56), to include Breckenridge Brewery, Redhook, and Shock Top. The all-cash acquisition, to be completed by the end of the year, will bring the breweries and all brewpubs associated with the brands under the Tilray name, joining Breckenridge Distillery, SweetWater Brewing, and the Alpine Beer Company.
The acquisition marks an interesting turn of events for Bud, which had been gobbling up formerly independent brewers at a breakneck pace. The company claims it remains committed to its craft beer portfolio, but recent layoffs and restructuring efforts bring those claims into question. With its $78 billion debt load (versus its market cap of $112 billion), it could certainly use the inflow of cash from the sale. As for Tilray, the purchase will make the company the fifth-largest craft brewer in the US.
When a company’s stock is selling for $2.50 per share, you tend to think wildly speculative name. While Tilray’s beta is extremely high (2.445), the company’s finances are actually quite strong (17.4% debt/equity ratio). Couple that with an intelligent strategic plan, and we could see the shares easily trading at $5 before long, which would be a 100% gain from here.
Tu, 29 Aug 2023
Specialty Retail
Best Buy beats, sees consumer demand for electronics troughing this year
We probably have more old investor notes on Best Buy (BBY $78) than just about any other company. That may seem strange, given its relatively small size and the industry it’s in, but we have always had an affinity for the consumer retailer. While we don’t currently own the $16 billion firm in any strategy right now, it does look compelling at $78 per share.
Best Buy released a good-looking Q2 earnings report early in the week, beating the Street’s expectations for both revenue and net income. Revenue came in at $9.58 billion versus the $9.52 billion expected, and the company posted earnings of $1.22 per share versus the $1.06 projected. CEO Corie Barry, at the helm for four years now, said that the industry still faces headwinds due to the “pull-forward in demand” in recent years (due to the pandemic), but that this year should reflect the low point. For the year, the company expects to earn around $6 to $6.40 from roughly $44 billion in sales.
Despite being the one remaining big-box electronics retailer left standing (remember Silo and Circuit City?), Best Buy has not been standing still. We like the company’s paid membership programs as a source of recurring revenue and a way to build stronger bonds with customers, and the ongoing redesign of stores to reflect the increase in digital sales. Roughly one-third of sales are now made online, and the physical stores are morphing into a mix of showroom, fulfillment center, and service area (Best Buy bought Geek Squad back in 2002).
Finally, Best Buy Health looks intriguing, but it is way too early to know if the program will be a success. The company has been forming alliances with health care providers to supply hardware and installation services to meet the medical needs of patients. Healthcare devices for remote monitoring are a key piece of the puzzle. If this unit can become profitable, it will be yet another reason to own the shares.
Best Buy has long attracted the attention of short sellers, but the firm continues to defy the haters. With its solid balance sheet, low multiple, and strong leader at the helm, we believe the shares are worth between $90 and $100.
Mo, 28 Aug 2023
Electric Utilities
Maui County sued Hawaiian Electric for the deadly wildfires; the utility is firing back
When I first got in the business, I recall making phone calls to clients or prospective clients about various investments. One broker I would often make these calls with began his greeting in a way that would make me put my hand over my eyes and shake my head: “Aloha, Mr./Ms. Smith! You may be wondering why I greeted you that way….” I still wince when I think of it. He was pushing shares of Hawaiian Electric (HE $13), provider of electricity for the five islands.
In addition to hoping the utility would conjure up images of the tropics in their minds, this broker sold the concept of owning a strong, regulated utility company with a fat (around 7% at the time), safe dividend yield. Who could argue with that logic? Unfortunately, nothing is certain in the world of investments. Case in point: Consider the breakup of the stalwart Bell System in the early 1980s and the tumult which ensued.
As for Hawaiian Electric, it had been a relatively stable performer for decades, with a rock-solid dividend. All of that changed virtually overnight with the tragic Maui wildfires. Before Maui County had even concluded its own investigation into the disaster, it sued the utility for negligence, claiming that power should have been shut down well before it was. In short, it blamed the company for the deaths which ensued. In a matter of days, HE’s share price dropped from $40 to $15; by Friday the 25th, shares had dropped to $9.06—their lowest level since 1985 and off 76% since the start of the year. The company immediately suspended its dividend, and a Forbes article opined that a Chapter 11 bankruptcy was “the most plausible path forward.”
By the following Monday, news hit that Hawaiian Electric did, in fact, “de-energize” its power lines in the region more than six hours before the fire which destroyed the town of Lahaina had begun. Furthermore, an earlier fire caused by a downed line had been quickly extinguished by the local fire department. The company turned the blame back to the county, and HE shares responded with a 40% surge within seconds of the open.
It's too early to predict what will ultimately happen in the courts, but the tragic incident should serve as a reminder to investors that even seemingly conservative investments can be hammered by unexpected events. Then again, anyone who had a large portion of their portfolios in the “safe” bond market in 2022 had already learned that lesson.
Utilities are the worst-performing sector over the past twelve months, off some 14%. When interest rates are relatively high, conservative investors tend to migrate out of utilities and into bonds for their income stream. However, virtually every portfolio should have at least a small portion allocated to this sector for proper diversification. We own several utility companies in the Strategic Income Portfolio and the Penn Global Leaders Club, and a 3% position in XLU, the Utilities Select Sector SPDR, within the Dynamic Growth Strategy.
Sa, 26 Aug 2023
Market Pulse
A bumpy five days marked by higher mortgage rates and Powell’s Jackson Hole comments
The S&P 500 vacillated between positive and negative returns this week, with each day closing in a different direction. Between mortgage rates hitting levels not seen since December 2000 and angst over what Fed Chair Jerome Powell would say at the Jackson Hole Symposium on Friday, investors were lucky to end the week relatively unscathed.
Tech stocks started out the week on fire after Softbank announced semiconductor giant Arm Holdings, formerly holding the symbol ARMH, would go public once again via an IPO. This time it will carry the symbol ARM. This company designs the architecture of chips which are found in nearly every single smartphone. While the exact valuation SoftBank will be seeking is not yet known, expect the company to open with a market cap of between $60 billion and $70 billion; also expect a flurry of IPO activity following this bombshell announcement. The NASDAQ finished up over 2% on the week, with most of the gains coming on Monday.
Boeing (BA $223) and Disney (DIS $83) held the Dow Jones Industrial Average in the red this week, with the latter dropping to price levels not seen since 2014. We have discussed ad nauseum what we think of both management teams. The small-cap Russell 2000 benchmark also finished in the red, while the S&P 500 managed to gain 82 basis points by Friday’s close.
As usual, investors didn’t know what to make of Powell’s presser, this one occurring at the Kansas City Fed’s Jackson Hole Economic Symposium. While they didn’t like the “we are not done yet (fighting inflation)” comments, his overall speech was relatively dovish. We continue to believe the Fed is done raising rates, but do not believe they will be in any hurry to lower rates in 2024. According to Mortgage News Daily, the average 30-year mortgage rate hit 7.48% this week before settling in around 7.23% on Friday. Oil closed Friday down about 1.66%, or $80.05 per barrel.
Next week’s big potential market movers will be the Case-Shiller Home Price Index on Tuesday, Salesforce’s results on Wednesday, and the August jobs report on Friday. Economists are looking for an additional 172,500 jobs for the month, down from 187,000 in July.
Fr, 25 Aug 2023
Electric Utilities
More than three decades later, a new nuclear power plant enters operation
It was seven years late and $17 billion over budget, but the first built-from-scratch domestic nuclear power plant in over thirty years is up and running. Georgia Power’s Plant Vogtle Unit 3, southeast of Augusta, will generate 1,100 megawatts of electricity, or enough to power 500,000 homes and businesses. Vogtle Unit 4 is also nearing completion, with expectations for a March 2024 production date.
Construction on the new plant began back in 2009 and has been marred by setbacks, including the 2017 bankruptcy of plant maker Westinghouse. The delays have taken a toll on Georgia Power’s parent company, utility giant Southern Co. (SO $68). That said, SO has outperformed the industry this year, down just 1.75% as compared to the Utilities Select Sector SPDR’s (XLU $64) 8.3% loss.
As for the future of nuclear power, while there are around 100 reactors planned or on order and another 300 proposed around the world, none are in the US. However, while there may not be any more of these massive Gen 3+ reactors built on US soil, the industry is betting on advanced, small modular reactors (SMR) known as Gen 4 units to carry it into the future. Oregon-based NuScale Power (SMR $6) has an agreement to build a first-of-its-kind modular reactor in Idaho, set to begin commercial operation by the end of the decade. Privately held TerraPower is working on another new reactor design, known as Natrium, which it is testing at a retired coal plant in Kemmerer, Wyoming.
While we expect Vogtle Units 3 and 4 to be the last of the traditional nuclear power plants built in the US, and the regulatory hurdles for the Gen 4 plants will be high, we still believe the industry has a critical role in the future of “green” energy in the country.
While an investment in SMR would be highly speculative, the Global X Uranium ETF (URA $23) is an interesting way to play the uranium-mining angle. It holds 49 of the world’s top uranium miners, with a 24% position in Cameco Corp (CCJ $36), arguably the world’s largest producer of the heavy metal. From a utilities standpoint, two companies with the largest exposure to nuclear power generation are Southern Co. and Entergy Corp (ETR $95), each with a 4.5% dividend yield.
Th, 24 Aug 2023
Metals & Mining
US Steel wants to be acquired; the steelworkers union wants to select the winning bidder
Sadly, the US steelmaking industry isn’t what it used to be. Take US Steel (X $31), which was trading around $200 per share in 2008 and bottomed out at $7.21 per share less than a decade later. Competition has become so keen in the industry—China now accounts for nearly half of the world’s output—that the storied US manufacturer, founded in 1901 by a group of potentates including Andrew Carnegie and J.P. Morgan, is actively searching for suitors.
This strategic review was fomented by multiple unsolicited bids, most notably Cleveland-Cliffs’ (CLF $15) $7.3 billion takeover offer; a proposal which was quickly rebuffed. All of this acquisition talk quickly drove up the share price of X from $22.50 to $32 in the matter of a week, but one other consideration needs to be factored in: the role of the United Steelworkers union (USW).
Esmark, an industrial conglomerate which made an all-cash bid for US Steel at a higher offering price than CLF, has already pulled its offer, citing the union’s support for the original bidder. An agreement between the company and the union specifies that if the USW supports one specific bidder, another company’s offer cannot be accepted unless the board of directors deems it superior. Furthermore, the buyer must either assume the existing labor contract or forge a new deal with the union before a transaction can take place. Needless to say, US Steel disagrees with this wide interpretation of the rules.
Yet another concern is the draconian FTC, headed by the anti-business activist Lina Khan. It is all but given that the agency would file lawsuits to stop a merger between two competing US steel companies—even if it meant a stronger hand against Chinese manufacturers. It appears that a deal will eventually get done, but the road ahead will be anything but smooth.
Investors who see value in this beaten-down industry (X has a multiple of 6) need to remember just how much the bottom line is affected by commodity prices, higher energy costs, competition from China, and economic conditions. As for US Steel, it is trading at or above fair market value due to the bidding war—in other words, an ultimate sale has already been baked into the price. As for the competitors mentioned, we don’t see any undervalued gems begging for investors to pounce. If we had to hold a position in the industry, it would be Japanese small-cap producer Yamato Kogyo Co Ltd (YMTKF $32, P/E ratio 4.4), which has major markets in Japan, South Korea, and Thailand. Consider any investment in the industry higher risk.
Tu, 22 Aug 2023
Leisure Equipment, Products, & Facilities
Dick’s Sporting Goods plunges by nearly 25%; it still doesn’t look cheap
It’s called “shrink,” but that’s just a politically correct way of saying theft. The condition was one of several reasons Dick’s Sporting Goods (DKS $112) gave for a disappointing earnings report; a report which caused shares to sink by nearly one-fourth in a matter of minutes.
On sales of $3.22 billion (analysts had been predicting $3.24B), the company earned $2.82 per share in the second quarter of the year. That is about 35% lighter than the Street expected. Management also reduced its full-year outlook, citing the resumption of student loan payments, a choppy economic environment, and the theft issue. Not showing up in this quarter’s results, the company will also have to shell out around $20 million in severance packets to recently laid off employees.
From our perspective, the biggest issues facing the retailer are increased competition in the space, a poor management team, discretionary cutbacks by consumers, and the lingering theft issue which few retailers have the courage to take on. And none of those issues are going to dissipate soon.
Consider the firm’s operating margin—the proportion of revenue left over after paying the variable costs of production. That measure of efficiency went from 16.5% in 2021 to 11.8% in 2022, and we expect the number to continue dropping as pricing power further erodes. Key vendors like Adidas and Nike have been strongly developing their own direct-to-consumer channels, reducing their dependence on third-party retailers such as Dick’s. Additionally, we see inflation continuing to constrict margins, as it is becoming more difficult to pass along higher prices on the type of elastic goods sold at the retailer. It may seem as though investors overreacted to this latest earnings report; considering the challenges ahead, however, we don’t think so.
With well-run competitors like Scheels (privately held) and Academy Sports and Outdoors (ASO $53) increasing market share, we see no reason to buy DKS on this hefty pullback; nor do we see any unique value proposition being presented by management.
Mo, 21 Aug 2023
Media & Entertainment
Iger’s tone-deaf response to falling subs: raise prices across the board
We had high hopes for entertainment powerhouse Disney (DIS $86) when the board finally gave Chapek the boot (shortly after extending his contract) and brought back former CEO Iger. We should have remembered our first thought after reading his autobiography: what an arrogant SOB. Indeed, Iger’s “I’m the greatest,” bull in a china shop approach has only wreaked more havoc on the company.
His latest misstep, fresh off the heels of ticking off Hollywood during a CNBC interview with David Faber, comes in his response to floundering Disney+ subscriptions. After giving mixed quarterly results for Q2, which included flatlining subscriber growth for the company’s streaming service, Iger announced that the ad-free version of Disney+ would now cost faithful subscribers 27% more. In addition to the $13.99 per month fee (up from $10.99), the company’s no-ad Hulu streaming service would jump 20%, from $14.99 to $17.99. Disney’s ad-supported service will remain $7.99 per month, but Iger even stepped in it with regards to that option. When pressed on the rate hikes, he flippantly indicated he would be just fine with subscribers dumping the ad model for the lower priced alternative, as the company would “make more via the ads.” Tone deaf.
An appropriate answer for slowing growth is never “let’s milk our faithful customers more for their current products and services,” but Iger doesn’t get it. While Disney’s streaming service has been a gamble from the start, the company always had its money-printing parks to serve as the cash cow, but even that is changing. Over the Independence Day weekend, wait times for rides at Disney’s US parks were the lowest they have been in over a decade—and no, that is not due to improvements in efficiency. It may, however, have something to do with the multiple price hikes implemented at the parks this year. Try this on for size: A one-person, one-day Park Hopper ticket for an adult (ten years or older) now costs up to $268.38. Happy sticking to one park for the day? Look to pay as much as $189.
We will always love the Disney experience, but something tells us Walt would clean house in the C-suite were he alive today. And who can blame him?
The first step to solving a problem is admitting you have one in the first place, and then accepting responsibility for it. Iger may say the right things (well, actually, not lately), but his arrogance will keep him from doing the right things. Until there are massive changes at the top, we don’t see owning this company in any of the Penn strategies.
We, 09 Aug 2023
Global Strategy: East/Southeast Asia
China’s economy continues to contract
As most of the developed world continues to grapple with inflation, China has quite a different challenge: fewer people—both at home and abroad—are buying Chinese goods, causing a serious case of deflation within the country.
China’s exports to the rest of the world fell 14.5% in July from the previous year, representing the sharpest downturn since February 2020—the earliest days of the pandemic. At home, real estate values are plunging, causing the average Chinese consumer to pull back on spending. Not only did consumer prices fall in July, producer prices fell for a tenth straight month, contracting 4.4% in July from the prior year.
As is always the case in a controlled economy, the Chinese Communist Party believes it can ride to the rescue with more government action. The People’s Bank of China is expected to reduce rates in an effort to spur economic activity, and the CCP has announced a new round of massive government spending. But even if it works at home (it won’t), how is that going to help reverse the contraction in exports? Chinese goods shipments to the US fell some 23% in July from the prior year, and shipments to the EU dropped around 20%.
After President for Life Xi announced his plans for global economic dominance while reiterating his support for Russia’s Putin, the Western world began scrambling to find alternate suppliers of goods to reduce reliance on the communist nation. While China’s exports to Russia have mushroomed since Putin’s invasion of Ukraine, that amounts to a drop in the bucket compared to the contracts which have been lost due to supply chain realignment. And China’s new exertion of control over quasi-private firms in the country will only exacerbate the problem. The only solution is a humble mea culpa by the regime and a distancing from Russia with respect to Ukraine, and there is zero chance that either of those actions will take place.
Chinese companies may seem appealing on the recent pull back, but investors should steer clear of the country for the international portion of their portfolios. Instead, consider India, Vietnam, Malaysia, and a host of other countries which are directly benefitting from the corporate migration away from China.
Tu, 08 Aug 2023
Beverages, Tobacco, & Cannabis
Cannabis company Tilray buying eight beer and beverage brands from Bud
It is no secret that our favorite Canadian cannabis company is Tilray (TLRY $2), run by the highly skilled beverage industry veteran Irwin Simon, founder of Hain Celestial Group. Despite the industry falling off the proverbial cliff over the past few years (Tilray shares topped out at $38 in February 2021), we still believe that a handful of players are destined to excel once they can legally operate in the US. In the meantime, Simon has been pursuing a bold path outside of the weed market—exemplified by this week’s news of a rather major acquisition.
Tilray has announced the purchase of eight beer and beverage brands from troubled brewer AB/InBev (BUD $56), to include Breckenridge Brewery, Redhook, and Shock Top. The all-cash acquisition, to be completed by the end of the year, will bring the breweries and all brewpubs associated with the brands under the Tilray name, joining Breckenridge Distillery, SweetWater Brewing, and the Alpine Beer Company.
The acquisition marks an interesting turn of events for Bud, which had been gobbling up formerly independent brewers at a breakneck pace. The company claims it remains committed to its craft beer portfolio, but recent layoffs and restructuring efforts bring those claims into question. With its $78 billion debt load (versus its market cap of $112 billion), it could certainly use the inflow of cash from the sale. As for Tilray, the purchase will make the company the fifth-largest craft brewer in the US.
When a company’s stock is selling for $2.50 per share, you tend to think wildly speculative name. While Tilray’s beta is extremely high (2.445), the company’s finances are actually quite strong (17.4% debt/equity ratio). Couple that with an intelligent strategic plan, and we could see the shares easily trading at $5 before long, which would be a 100% gain from here.
Headlines for the Month of July, 2023
Sa, 29 Jul 2023
Market Pulse
It was a busy—and generally positive—week in the markets
What a week. The fireworks began on Tuesday, when it appeared as though we were on the cusp of yet another regional bank failure. As quickly as the concern over California regional PacWest Bancorp (PACW $9) reared its ugly head, it dissipated with news that smaller regional Banc of California (BANC $14) would acquire it, maintaining the latter's name. It's a crazy world. Going into the year, PacWest had a market cap of just under $3 billion, while BANC's market cap was around $1 billion. Thank JP Morgan's Jamie Dimon—it's a long story. Anyway, crisis averted.
On Wednesday the Fed raised interest rates another 25 basis point, to 5.50%. That brings it up to a rate not seen since January of 2001. It had about a 100% chance of happening, so the markets shrugged off the move. Inflation is clearly coming down and credit card debt is at a new record high, so it is time to stop hiking. But will they?
Thursday brought an unexpectedly high GDP report for the second quarter. The US economy grew at 2.4%, handily beating expectations and coming on the heels of a 2% Q1 growth rate. Consumer spending also surprised analysts, and the labor market remains strong. Even housing prices resumed their upward trend, despite a 30-year mortgage rate near 7%. A dearth of homes on the market helped that metric; who wants to sell and lose their 3.5% mortgage rate?
Friday capped the week off with a stunning show of strength. The S&P 500 gained nearly 1%, the Nasdaq rose nearly 2%, and the Russell 2000 (small caps) gained 1.36%. Unfortunately, oil rose nearly 4% on the week, and the spike is definitely filtering through to the price of gas. At the start of the week, we saw prices floating around $3.11 per gallon; by the weekend, they were close to $3.60 per gallon—a 16% increase.
We are unsettled by the news that credit card debt just hit another record high, and we wonder how many people even realize they are paying around 22% in interest on their balances (the national average). Then again, US debt is about to hit $33 trillion—well above the size of the US economy, so why should the population be any more responsible than the people they elect? We will take the win in the markets for the week, and the risk of a recession is diminishing, but debt trouble is brewing. If a politician is blathering on about the need for more government spending but never mentions the national debt, they should be run out of D.C. on a rail. More evidence of the need for a balanced budget amendment to the US Constitution and term limits.
Tu, 25 Jul 2023
Specialty Retail: E-Commerce
Overstock.com will buy the intellectual property of Bed Bath & Beyond
It turns out Bed Bath & Beyond (BBBY $0.31) is not going away after all. Well, the 260 (down from 1,500 five years ago) remaining stores may be, but the name will live on. It seems that Overstock.com (OSTK $31) has been trying to break the stigma for years that it is nothing but a liquidator of goods. Considering that concept is literally in the name of the firm, the $1.4 billion online retailer has agreed to purchase BBBY’s intellectual property, customer lists, and website domain for $21.5 million in cash. Honestly, that seems like a real bargain if they can actually pull it off.
Investors are applauding the deal, pulling the shares up from just above $17 in June to just under $31 as we write this. In Canada, online shoppers who visit bedbathandbeyond.ca website will now be taken to the Overstock site, with the US rollout expected by the end of summer. The fit just seems right—the two companies’ sites look almost identical.
Despite the low cost of acquisition and the enormous name recognition of the acquired, one lingering question remains: Without a physical presence, what percentage of Bed Bath & Beyond bricks-and-mortar shoppers—most of whom armed with 20% coupons in hand as they lingered the aisles—will take to the online store? After all, if you can’t walk around and find in-store deals, isn’t it easier just to visit Amazon.com? Then again, couldn’t that have been said of Overstock.com before this deal?
For $21.5 million, Overstock made a smart move. For a fully online company, we could imagine them getting lost in ubiquity before long, looking a lot like most other home furnishings retailers. At least the new name will make them stand out a bit more. Another plus: the company’s balance sheet is very strong, with virtually no debt on the books. Imagine the overhead of those Bed Bath and Beyond behemoths, and it is easy to understand why they were awash in debt. Is OSTK (not sure whether they will change that ticker) worthy of an investment? With no dividend and a fair market value—in our opinion—of $35 per share, they seem close to fairly valued. Too bad we can’t use a 20% coupon on the stock price.
Tu, 18 Jul 2023
Telecom Services
AT&T shares fall to lowest level in three decades—Verizon not looking much better
Two years ago this October, we posed the question: “Over the course of twenty years, AT&T (T $13) shares have dropped 43%; is it time to buy?” We concluded that, based on the maladroit leadership team’s missteps, such as overpaying for ill-advised acquisitions instead of addressing a poor customer service problem, it was decidedly not time to buy, despite an enticing dividend yield. At the time, T shares were trading for $26 and offered a dividend yield north of 5%; in the two years since we wrote that article, they have fallen precisely 50%.
The telecom giant’s latest headache stems from a Wall Street Journal report claiming that the company—along with other industry players, chiefly Verizon (VZ $33)—left behind over 2,000 lead-encased cables which remain buried throughout the United States. The publication claims its testing showed toxic lead leaching into soil and waterways around the cables at levels exceeding government standards. This begs the question, what are the potential liabilities once the class action lawsuits begin—and we all know they will. The ultimate legal costs could be staggering.
Verizon shares were also affected by the report, falling over 7% on Monday and bringing them down to their lowest level since 2010. It should be noted that both T and VZ now have dividend yields around 8.25%, give or take five basis points. AT&T shot back to the contamination issue by stating that the Journal’s conclusion flies in the face of “long-standing science” regarding the safety of lead-clad cables. That position certainly won’t staunch the flood of litigation that is sure to come down the pike, but it does give us insight into the industry’s probable defense. New Street Research estimates that the removal of all remaining cables of this type would cost in the ballpark of $59 billion; of course, that is on top of any future legal costs. As of this writing, T has a market cap of just under $100 billion, while Verizon’s market cap sits just under $140 billion.
Forget the fat dividend yields; steer clear of these two telecom giants. For an industry holding, investors may want to consider T-Mobile (TMUS $140), with its 19 forward P/E. It doesn’t offer a yield, but it sure seems to offer more growth potential than T or VZ.
Mo, 17 Jul 2023
Government Watchdog
The FTC’s inept chairperson loses yet another case: Microsoft will buy Activision
Last December, when the FTC’s buffoonish leader, Lina Khan, sued Microsoft (MSFT $345) to stop them from buying video game publisher Activision Blizzard (ATVI $90) in a $69 billion deal, we predicted the case would be laughed out of court. That just happened, and it happened at the hands of a Biden-appointed judge. Making matters worse (for the American taxpayer), following this blistering rebuke of the FTC Khan ordered her organization to appeal the decision. On what possible grounds does she still have a job?
As we were writing about the case last December, we were struck by how cavalier the respective management teams had been about the lawsuit and the current state of the commission. They offered nothing to the government other than a promise to fight—and win—the case. There was, after all, nothing anticompetitive about the deal. In a show of good faith, Microsoft even agreed in writing to continue allowing Activision’s mammoth hit, “Call of Duty,” to remain on Sony’s (SONY $94) PlayStation with the same level of availability it enjoyed on the company’s own Xbox platform.
When she ascended to the spot—virtually straight out of law school, Khan sent shudders through the corporate world as many executives feared the FTC would grind M&A activity to a halt. She held up her end of the threat via the mountain of lawsuits filed by the FTC since she took the helm; they have just been shot down at a historic rate by the courts. The person they once feared is now seen as a paper tiger, and that is putting it kindly. This past February, one of the FTC commissioners resigned and expressed her dismay at Khan’s “disregard for the rule of law.” It appears the courts agree with that assessment.
Khan’s latest target is another member of the Penn Global Leaders Club, Amazon (AMZN $134). She is claiming that it is too difficult for Prime members to cancel their subscription. We are not going too far out on the limb by predicting another win for corporate America and yet another black mark on Khan’s record. But how many more taxpayer dollars will be lost on yet another frivolous lawsuit? When a nation is $32 trillion in debt, we suppose few are really counting any longer.
Th, 13 Jul 2023
Global Organizations & Accords
In surprising turn of events, Turkey agrees to Sweden’s NATO accession
For more than a year, Turkish President Recep Tayyip Erdogan has foiled Sweden’s bid to become NATO’s 32nd member, seemingly milking his Western allies for all he could get to support the move. Now, in a rather stunning turn of events, Erdogan has agreed to approve Sweden’s bid, making the alliance stronger than it has ever been.
For generations, Nordic countries Sweden and Finland shunned joining the alliance in an effort to assuage Russia’s security concerns; shortly after Putin’s wanton invasion of Ukraine, both countries applied for membership—with a majority of their respective citizenry supporting the move. To enter the alliance, all current member-states must vote to approve. After a hard-fought battle to win over Hungary and Turkey, Finland was formally invited in earlier this year. Erdogan’s seemingly insatiable demands made it appear that Sweden’s membership remained a long way off.
Just hours before a NATO summit was to begin in the Lithuanian capital of Vilnius, however, NATO Secretary-General Jens Stoltenberg made the surprise announcement that Turkey had formally approved Sweden’s bid to become a member “as soon as possible.” Concessions were no doubt made, but this is a huge move and a deeply troubling one for Putin, who now finds himself enveloped by the alliance on his northern, western, and southern flanks. With this latest move, hundreds of warplanes, tanks, and tens of thousands of additional troops will strengthen NATO’s dominant military position on the continent.
For Sweden’s part, the country agreed to Erdogan’s demands to crack down on members of the Kurdish Workers’ Party, or PKK, operating within Sweden. This Marxist group has been fighting Turkish forces since the 1980s. Ironically, Sweden was one of the first countries to label the group a terrorist organization, so it is unclear what further promises were made. As for the US, President Biden tied the sale to Turkey of $20 billion worth of General Dynamics/Lockheed Martin F-16 Fighting Falcons to Erdogan’s approval. While obstacles may remain in Congress, the deal will certainly now go through.
As for the EU, Erdogan wanted assurances that his country would become a member of the Union. While European leaders balked at a direct promise, they did agree to reevaluate Turkey’s bid “with a view to proceed in a strategic and forward-looking manner.” A lot of moving parts remain, but one thing is certain: it was an excellent day for Sweden and NATO, and another really bad day for the Russian menace.
Putin’s true friends are now limited to the likes of China, North Korea, Iran, Belarus, and Brazil—the latter only as long as the socialist Lula da Silva remains in power. Talk about a motley crew. As for the country he invaded, Ukraine continues to push for entry into the Western alliance, with an increasing number of members ready to support that move.
Th, 13 Jul 2023
Economics: Housing
Multifamily housing is going up at a clip not seen since 1986, meaning rental prices should continue to moderate
Something rather amazing happened over the course of the year through this past May: According to apartment search engine and online marketplace Rent.com, monthly rental prices fell 0.57%. That represents the first drop in prices since March 2022, and comes on the heels of a year in which the average renter paid 17.5% more than they did the previous year. Despite this good news, consider this: The national median rent is now $1,995 per month. Rents may finally be moderating, but that is still a lofty figure. More good news may be on the horizon, however.
After years of being underdeveloped, construction is soaring once again. In May, privately-owned multifamily unit starts hit 624,000, up from a trough of 234,000 in April 2020. That is the fastest clip of new units since April 1986. Meanwhile, Month-over-month (MoM) housing starts for May rose a robust 21.7%—the fastest pace since October 2016. In addition to supply ramping up, inflation is clearly moderating. One other factor should help put downward pressure on rent prices: the average American budget is getting tighter. Not only are the pandemic piggy banks running out of money after three years of wanton discretionary spending, the resumption of student loan payments this September will further crimp the budget of millions of American families. The supply and demand dynamic of multifamily housing is about to make a rather dramatic shift.
In the next issue of The Penn Wealth Report we will take a closer look at this topic and what it means not only for renters, but for developers and those who hold apartment REITs in their portfolios. One housing research firm sees apartment values dropping another 20% between now and the end of next year, meaning investors should pay special attention to this corner of the real estate market and consider placing stops on positions to help protect their principal.
Sa, 29 Jul 2023
Market Pulse
It was a busy—and generally positive—week in the markets
What a week. The fireworks began on Tuesday, when it appeared as though we were on the cusp of yet another regional bank failure. As quickly as the concern over California regional PacWest Bancorp (PACW $9) reared its ugly head, it dissipated with news that smaller regional Banc of California (BANC $14) would acquire it, maintaining the latter's name. It's a crazy world. Going into the year, PacWest had a market cap of just under $3 billion, while BANC's market cap was around $1 billion. Thank JP Morgan's Jamie Dimon—it's a long story. Anyway, crisis averted.
On Wednesday the Fed raised interest rates another 25 basis point, to 5.50%. That brings it up to a rate not seen since January of 2001. It had about a 100% chance of happening, so the markets shrugged off the move. Inflation is clearly coming down and credit card debt is at a new record high, so it is time to stop hiking. But will they?
Thursday brought an unexpectedly high GDP report for the second quarter. The US economy grew at 2.4%, handily beating expectations and coming on the heels of a 2% Q1 growth rate. Consumer spending also surprised analysts, and the labor market remains strong. Even housing prices resumed their upward trend, despite a 30-year mortgage rate near 7%. A dearth of homes on the market helped that metric; who wants to sell and lose their 3.5% mortgage rate?
Friday capped the week off with a stunning show of strength. The S&P 500 gained nearly 1%, the Nasdaq rose nearly 2%, and the Russell 2000 (small caps) gained 1.36%. Unfortunately, oil rose nearly 4% on the week, and the spike is definitely filtering through to the price of gas. At the start of the week, we saw prices floating around $3.11 per gallon; by the weekend, they were close to $3.60 per gallon—a 16% increase.
We are unsettled by the news that credit card debt just hit another record high, and we wonder how many people even realize they are paying around 22% in interest on their balances (the national average). Then again, US debt is about to hit $33 trillion—well above the size of the US economy, so why should the population be any more responsible than the people they elect? We will take the win in the markets for the week, and the risk of a recession is diminishing, but debt trouble is brewing. If a politician is blathering on about the need for more government spending but never mentions the national debt, they should be run out of D.C. on a rail. More evidence of the need for a balanced budget amendment to the US Constitution and term limits.
Tu, 25 Jul 2023
Specialty Retail: E-Commerce
Overstock.com will buy the intellectual property of Bed Bath & Beyond
It turns out Bed Bath & Beyond (BBBY $0.31) is not going away after all. Well, the 260 (down from 1,500 five years ago) remaining stores may be, but the name will live on. It seems that Overstock.com (OSTK $31) has been trying to break the stigma for years that it is nothing but a liquidator of goods. Considering that concept is literally in the name of the firm, the $1.4 billion online retailer has agreed to purchase BBBY’s intellectual property, customer lists, and website domain for $21.5 million in cash. Honestly, that seems like a real bargain if they can actually pull it off.
Investors are applauding the deal, pulling the shares up from just above $17 in June to just under $31 as we write this. In Canada, online shoppers who visit bedbathandbeyond.ca website will now be taken to the Overstock site, with the US rollout expected by the end of summer. The fit just seems right—the two companies’ sites look almost identical.
Despite the low cost of acquisition and the enormous name recognition of the acquired, one lingering question remains: Without a physical presence, what percentage of Bed Bath & Beyond bricks-and-mortar shoppers—most of whom armed with 20% coupons in hand as they lingered the aisles—will take to the online store? After all, if you can’t walk around and find in-store deals, isn’t it easier just to visit Amazon.com? Then again, couldn’t that have been said of Overstock.com before this deal?
For $21.5 million, Overstock made a smart move. For a fully online company, we could imagine them getting lost in ubiquity before long, looking a lot like most other home furnishings retailers. At least the new name will make them stand out a bit more. Another plus: the company’s balance sheet is very strong, with virtually no debt on the books. Imagine the overhead of those Bed Bath and Beyond behemoths, and it is easy to understand why they were awash in debt. Is OSTK (not sure whether they will change that ticker) worthy of an investment? With no dividend and a fair market value—in our opinion—of $35 per share, they seem close to fairly valued. Too bad we can’t use a 20% coupon on the stock price.
Tu, 18 Jul 2023
Telecom Services
AT&T shares fall to lowest level in three decades—Verizon not looking much better
Two years ago this October, we posed the question: “Over the course of twenty years, AT&T (T $13) shares have dropped 43%; is it time to buy?” We concluded that, based on the maladroit leadership team’s missteps, such as overpaying for ill-advised acquisitions instead of addressing a poor customer service problem, it was decidedly not time to buy, despite an enticing dividend yield. At the time, T shares were trading for $26 and offered a dividend yield north of 5%; in the two years since we wrote that article, they have fallen precisely 50%.
The telecom giant’s latest headache stems from a Wall Street Journal report claiming that the company—along with other industry players, chiefly Verizon (VZ $33)—left behind over 2,000 lead-encased cables which remain buried throughout the United States. The publication claims its testing showed toxic lead leaching into soil and waterways around the cables at levels exceeding government standards. This begs the question, what are the potential liabilities once the class action lawsuits begin—and we all know they will. The ultimate legal costs could be staggering.
Verizon shares were also affected by the report, falling over 7% on Monday and bringing them down to their lowest level since 2010. It should be noted that both T and VZ now have dividend yields around 8.25%, give or take five basis points. AT&T shot back to the contamination issue by stating that the Journal’s conclusion flies in the face of “long-standing science” regarding the safety of lead-clad cables. That position certainly won’t staunch the flood of litigation that is sure to come down the pike, but it does give us insight into the industry’s probable defense. New Street Research estimates that the removal of all remaining cables of this type would cost in the ballpark of $59 billion; of course, that is on top of any future legal costs. As of this writing, T has a market cap of just under $100 billion, while Verizon’s market cap sits just under $140 billion.
Forget the fat dividend yields; steer clear of these two telecom giants. For an industry holding, investors may want to consider T-Mobile (TMUS $140), with its 19 forward P/E. It doesn’t offer a yield, but it sure seems to offer more growth potential than T or VZ.
Mo, 17 Jul 2023
Government Watchdog
The FTC’s inept chairperson loses yet another case: Microsoft will buy Activision
Last December, when the FTC’s buffoonish leader, Lina Khan, sued Microsoft (MSFT $345) to stop them from buying video game publisher Activision Blizzard (ATVI $90) in a $69 billion deal, we predicted the case would be laughed out of court. That just happened, and it happened at the hands of a Biden-appointed judge. Making matters worse (for the American taxpayer), following this blistering rebuke of the FTC Khan ordered her organization to appeal the decision. On what possible grounds does she still have a job?
As we were writing about the case last December, we were struck by how cavalier the respective management teams had been about the lawsuit and the current state of the commission. They offered nothing to the government other than a promise to fight—and win—the case. There was, after all, nothing anticompetitive about the deal. In a show of good faith, Microsoft even agreed in writing to continue allowing Activision’s mammoth hit, “Call of Duty,” to remain on Sony’s (SONY $94) PlayStation with the same level of availability it enjoyed on the company’s own Xbox platform.
When she ascended to the spot—virtually straight out of law school, Khan sent shudders through the corporate world as many executives feared the FTC would grind M&A activity to a halt. She held up her end of the threat via the mountain of lawsuits filed by the FTC since she took the helm; they have just been shot down at a historic rate by the courts. The person they once feared is now seen as a paper tiger, and that is putting it kindly. This past February, one of the FTC commissioners resigned and expressed her dismay at Khan’s “disregard for the rule of law.” It appears the courts agree with that assessment.
Khan’s latest target is another member of the Penn Global Leaders Club, Amazon (AMZN $134). She is claiming that it is too difficult for Prime members to cancel their subscription. We are not going too far out on the limb by predicting another win for corporate America and yet another black mark on Khan’s record. But how many more taxpayer dollars will be lost on yet another frivolous lawsuit? When a nation is $32 trillion in debt, we suppose few are really counting any longer.
Th, 13 Jul 2023
Global Organizations & Accords
In surprising turn of events, Turkey agrees to Sweden’s NATO accession
For more than a year, Turkish President Recep Tayyip Erdogan has foiled Sweden’s bid to become NATO’s 32nd member, seemingly milking his Western allies for all he could get to support the move. Now, in a rather stunning turn of events, Erdogan has agreed to approve Sweden’s bid, making the alliance stronger than it has ever been.
For generations, Nordic countries Sweden and Finland shunned joining the alliance in an effort to assuage Russia’s security concerns; shortly after Putin’s wanton invasion of Ukraine, both countries applied for membership—with a majority of their respective citizenry supporting the move. To enter the alliance, all current member-states must vote to approve. After a hard-fought battle to win over Hungary and Turkey, Finland was formally invited in earlier this year. Erdogan’s seemingly insatiable demands made it appear that Sweden’s membership remained a long way off.
Just hours before a NATO summit was to begin in the Lithuanian capital of Vilnius, however, NATO Secretary-General Jens Stoltenberg made the surprise announcement that Turkey had formally approved Sweden’s bid to become a member “as soon as possible.” Concessions were no doubt made, but this is a huge move and a deeply troubling one for Putin, who now finds himself enveloped by the alliance on his northern, western, and southern flanks. With this latest move, hundreds of warplanes, tanks, and tens of thousands of additional troops will strengthen NATO’s dominant military position on the continent.
For Sweden’s part, the country agreed to Erdogan’s demands to crack down on members of the Kurdish Workers’ Party, or PKK, operating within Sweden. This Marxist group has been fighting Turkish forces since the 1980s. Ironically, Sweden was one of the first countries to label the group a terrorist organization, so it is unclear what further promises were made. As for the US, President Biden tied the sale to Turkey of $20 billion worth of General Dynamics/Lockheed Martin F-16 Fighting Falcons to Erdogan’s approval. While obstacles may remain in Congress, the deal will certainly now go through.
As for the EU, Erdogan wanted assurances that his country would become a member of the Union. While European leaders balked at a direct promise, they did agree to reevaluate Turkey’s bid “with a view to proceed in a strategic and forward-looking manner.” A lot of moving parts remain, but one thing is certain: it was an excellent day for Sweden and NATO, and another really bad day for the Russian menace.
Putin’s true friends are now limited to the likes of China, North Korea, Iran, Belarus, and Brazil—the latter only as long as the socialist Lula da Silva remains in power. Talk about a motley crew. As for the country he invaded, Ukraine continues to push for entry into the Western alliance, with an increasing number of members ready to support that move.
Th, 13 Jul 2023
Economics: Housing
Multifamily housing is going up at a clip not seen since 1986, meaning rental prices should continue to moderate
Something rather amazing happened over the course of the year through this past May: According to apartment search engine and online marketplace Rent.com, monthly rental prices fell 0.57%. That represents the first drop in prices since March 2022, and comes on the heels of a year in which the average renter paid 17.5% more than they did the previous year. Despite this good news, consider this: The national median rent is now $1,995 per month. Rents may finally be moderating, but that is still a lofty figure. More good news may be on the horizon, however.
After years of being underdeveloped, construction is soaring once again. In May, privately-owned multifamily unit starts hit 624,000, up from a trough of 234,000 in April 2020. That is the fastest clip of new units since April 1986. Meanwhile, Month-over-month (MoM) housing starts for May rose a robust 21.7%—the fastest pace since October 2016. In addition to supply ramping up, inflation is clearly moderating. One other factor should help put downward pressure on rent prices: the average American budget is getting tighter. Not only are the pandemic piggy banks running out of money after three years of wanton discretionary spending, the resumption of student loan payments this September will further crimp the budget of millions of American families. The supply and demand dynamic of multifamily housing is about to make a rather dramatic shift.
In the next issue of The Penn Wealth Report we will take a closer look at this topic and what it means not only for renters, but for developers and those who hold apartment REITs in their portfolios. One housing research firm sees apartment values dropping another 20% between now and the end of next year, meaning investors should pay special attention to this corner of the real estate market and consider placing stops on positions to help protect their principal.
Headlines for the Month of June, 2023
Tu, 27 Jun 2023
Drug Retail
Walgreens hasn’t traded this low since June 2010; what gives?
One would think that an enormous retail pharmacy chain would be relatively immune to a slowing economy and a pullback in consumer spending. Prescription drugs are pretty important, after all. Why, then, are shares of Walgreens Boots Alliance (WBA $29) sitting at their lowest point in precisely thirteen years? After reporting an abysmal fiscal third quarter and slashing its full-year guidance, management blamed “challenging consumer and macroeconomic conditions.” We don’t buy any of that.
Despite management’s comments, sales rose 8.65% from the same quarter last year, to $35.42 billion. The disconnect came in net income, which fell from $289 million in fiscal Q3 of 2022 to $118 million in the latest quarter—nearly a 60% plunge. The company reported a $3.72 billion loss two quarters ago after paying a massive opioid settlement, but that is in the rear-view mirror. We see the challenges driven more by increased competition than economic conditions or a “drop off in Covid-related sales.”
CEO Rosalind Brewer said the company will increase its cost-cutting initiative to $4.1 billion and take other steps to increase profitability in its health care segment, but with Amazon (AMZN $127) Pharmacy gaining momentum, and multiline retailers like Target (TGT $134) and Walmart (WMT $155) increasing market share, will that be enough? We don’t think so. Even at a thirteen-year low, the share price doesn’t look that attractive. It is going to take an intelligent strategic initiative to garner our interest once more, and we don’t see management bringing anything like that to the table.
We closed Walgreens from the Penn Global Leaders Club at $36 per share in November 2020. Up until that point, it had been a staple company in the portfolio.
Fr, 23 Jun 2023
Restaurants
The Cava IPO proves that (too) many haven’t gotten any smarter since the downturn
It felt like the old days; the New York Stock Exchange was all abuzz about a new IPO. Cava Group (CAVA $40), owner of CAVA Mediterranean restaurants and Zoe’s Kitchen, which the company bought back in 2018 and has been converting to CAVA locations ever since, was going public. How exciting. Never mind the fact that Zoe’s was publicly traded between 2014 and 2018 before agreeing to be bought out at a value below its IPO price, this time is different.
With the IPO priced at $22 per share for the Mr. Howells and Daddy Warbucks of the world, by the time us hoi polloi had a chance to buy in at the open the price had doubled—topping out at $47.89 within hours. Unlike Airbnb (ABNB $125) or CrowdStrike Holdings (CRWD $144), however, we weren’t the least bit bummed out that we weren’t part of the trading elite.
It seems as though the only carrot much of the investment community needs is a good story to forget their meme stock, crypto, and NFT losses, and pundits quickly offered them one: CAVA was going to be the next Chipotle (CMG $2,045). Cha-ching! Why let discounted cash flow models or actual profits get in the way of a good story? At least with respect to this IPO, it feels like the frothy days of a few years ago. Let the dumb money chase the flashy stories; we still see many unloved bargains sitting out there for astute and selective investors.
This is no disparagement of CAVA; in fact, we want to try the place now. However, investors who bought in on day one or who will buy in anywhere above the IPO price will lose on this one. Think Sweetgreen (SG $11), not Chipotle.
Fr, 23 Jun 2023
Aerospace & Defense
When your company is a perennial money loser, is it wise to go on strike?
That is a rhetorical question. Spirit AeroSystems (SPR $27), which was spun out of Boeing (BA $203) in 2005, designs and manufactures aerostructures—primarily fuselages—for commercial and military aircraft. Boeing and Airbus (EADSY $34) are the company’s two primary customers, with the former generating 80% of the firm’s revenue. In fact, the supplier is responsible for a majority of the Boeing 737’s airframe. The company lost $761 million over the trailing twelve months, $539 million in 2022, $555 million in 2021, and $1.1 billion in 2020. Unionized workers at Spirit just voted overwhelmingly to reject the company’s “best and final offer” and go on strike.
Analysts had considered the company’s last offer “steep but necessary,” as the industry faces mounting challenges even without a strike threat on the table. Spirit offered a 16% pay hike over four years, a $7,500 signing bonus, cost of living adjustments, and annual bonuses—adding up to an aggregate 34% increase over four years. An offer so generous that the the International Association of Machinists and Aerospace Workers (IAM) representatives at the bargaining table recommended its acceptance. At the vote, 79% of union workers rejected the offer, and 85% formally voted to go on strike. Spirit immediately told the organized workers not to report back to work for their shifts on the 22nd of June.
Shares of Spirit and Boeing fell sharply on the rejection, while Airbus shares remained largely unaffected.
Spirit has been losing money for three straight years; this type of manufacturing environment is ready-made for automation and a robotic workforce. The actions belie logic. As for Boeing, we wouldn’t consider touching the shares until their inept CEO, David Calhoun, and most of the board are shown the door.
Tu, 13 Jun 2023
Automotive
Tesla strikes deal with both Ford and GM for use of its Supercharger network
Over a decade ago, EV leader Tesla (TSLA $250) introduced its Supercharger network to overcome buyer angst over hitting the highways in an electric vehicle. In typical Tesla fashion, the company invited other American automakers to adopt their charging methods (NACS, or North American Charging Standard) to help grow the industry. They were rebuffed in a not-so-polite manner. Now, after a decade of Tesla dominance in the EV race, the competition’s haughty attitude has changed.
Drivers of non-Tesla EVs have been forced to use a rather spotty and unreliable system known as CCS, or Combined Charging System. With Ford (F $14) and GM (GM $37) planning on producing millions of electric vehicles per year, this condition has become unacceptable. That is why, over the course of a few weeks, both automakers have inked deals adopting Tesla’s Supercharger standard. Phase one will involve their vehicles coming equipped with an adapter allowing them to use Tesla’s network. Within a few years, compatible plugs will come standard on the vehicles.
What does this mean for Tesla? Naysayers argue the move only helps the company’s competitors sell more EVs and catch up to the leader. Baloney. What it really means is a great new source of revenue as Ford and GM vehicles roll up and plug in. It also highlights the leadership of Tesla within the industry. Tesla’s senior director of charging infrastructure, Rebecca Tinucci, reiterated the company’s mission to “accelerate the world’s transition to sustainable energy.” These new deals will help with that acceleration.
Tesla currently operates 45,000 Superchargers at over 5,000 locations, and the company’s pre-fab system means a new station can be up and running within eight days. Expect the explosive growth of these locations to continue until they are virtually everywhere on American roads. We own Tesla, which is up 103% year-to-date as of this writing, in the Penn New Frontier Fund.
Th, 08 Jun 2023
Economics: Work & Pay
The latest jobless report: another reason the Fed should stop hiking
The number of Americans who applied for unemployment benefits in early June spiked to 261,000, matching July 2022 figures and representing the highest rate since November 2021. The four-week moving average rose to 237,250, and we expect to see that average continue to climb in the face of a softening economy. While that’s bad news for workers, it is good news for those wishing the Fed would finally end its rate hike cycle, and for Americans looking for lower prices at the pump and in the grocery stores.
While the Labor Department didn’t cite specifics for the unexpected jump, the breakdown is interesting: Out of 53 states and territories 26 showed a decrease in claims, 27 had an increase, and two states—California and Ohio—saw a surge in claims. All of the tech layoffs almost certainly accounted for California’s job losses, in addition to companies exiting the state. Rising claims are a leading economic indicator for the economy and often a telltale sign we are nearing a recession. That said, other indicators—such as corporate earnings—point to a quite mild recession, assuming we have one at all.
Thanks to his hawkish—and quite unnecessary—recent comments, most analysts believe we will see another rate hike in July. We have changed our tune (thanks to Powell's rhetoric) and agree with that prediction. After either one or two more hikes, we see an elongated pause going well into 2024. We view the 5% federal funds rate as the sweet spot: not high enough to hurt the US economy, but robust enough to provide cash-starved investors with some real yield for the first time in a decade. Sadly, Powell doesn't want to seem to stop his tightening.
As for fixed-income maturities, we are moving out our duration sweet spot to 5-7 years. We will continue to buy on the shorter end as well, but now feel comfortable walking up a few more steps on the duration ladder.
Mo, 05 Jun 2023
South Asia
The expulsion of each other's journalists is just the latest flashpoint in the deteriorating relations between India and China
"The enemy of my enemy is my friend?" Sadly, considering India's tight relationship with Russia's Putin, that saying doesn't really apply with respect to India's ongoing Cold War (which is, at times, hot) with China, but it is fascinating to watch from a distance.
The latest flare-up comes after each country kicked out the other's journalists, with India denying visa renewals to Chinese state media personnel, and China quickly reciprocating. Tensions between the two neighbors, which share a 2,100-mile border, have been steadily growing over the past several years, marked by border conflicts and economic disputes.
Not long after the Chinese-borne pandemic began, a deadly clash took place in the Himalayan Mountains along a stretch of land claimed by both countries; specifically, the Aksai Chin region. Twenty Indian soldiers and an unknown number of Chinese troops were killed in the fighting, marking the lowest point in relations between the two countries in decades. According to a senior Indian military official, several of the soldiers were killed by clubs embedded with nails.
It doesn't take much for a hyper-sensitive China, emboldened by a growing economy, to react violently to perceived threats. In addition to aggressive behavior along the Indian border, the country has claimed a number of disputed islands in the South China Sea as its own, alienating southern and eastern neighbors in the region.
The CCP has also expressed outrage at the existence of the Quadrilateral Security Dialogue, a geopolitical group made up of the United States, Japan, India, and Australia. It claims the group's purpose is to encircle and isolate the country, though the stated goal of the Quad, as it is known, is to monitor illegal fishing, maritime militias, and the secret shipping of goods such as weapons.
China's inferiority complex with respect to its role on the world stage is troubling. The more it feels slighted, the more the country's military is apt to act in an irresponsible way, as highlighted by the recent border dispute. Unfortunately, India's close relationship with Russia illustrates the nuanced approach the US must take when forming strategic alliances in the region.
As China's economy matures, it will become impossible to maintain the high growth rate it displayed as an emerging market. The arrogance of the country's ruling class will prevent them from accepting that fact, which will lead to ever-growing tumult in the region. For the international portion of any investment portfolio, we see greener pastures outside of both China and India.
Mo, 05 Jun 2023
Leisure Equipment, Products, and Facilities
BofA: Reiterate bullish views on Topgolf Callaway
After meeting with senior executives, Bank of America reiterated its bullish outlook on Penn member (Intrepid Trading Platform) Topgolf Callaway (MODG $19). Analysts were especially impressed with Project PIE, the company's new digital bay inventory system, which should greatly increase the utilization rate at Topgolf—the unit responsible for 39% of sales. We have a $30 per share price target on MODG.
Tu, 27 Jun 2023
Drug Retail
Walgreens hasn’t traded this low since June 2010; what gives?
One would think that an enormous retail pharmacy chain would be relatively immune to a slowing economy and a pullback in consumer spending. Prescription drugs are pretty important, after all. Why, then, are shares of Walgreens Boots Alliance (WBA $29) sitting at their lowest point in precisely thirteen years? After reporting an abysmal fiscal third quarter and slashing its full-year guidance, management blamed “challenging consumer and macroeconomic conditions.” We don’t buy any of that.
Despite management’s comments, sales rose 8.65% from the same quarter last year, to $35.42 billion. The disconnect came in net income, which fell from $289 million in fiscal Q3 of 2022 to $118 million in the latest quarter—nearly a 60% plunge. The company reported a $3.72 billion loss two quarters ago after paying a massive opioid settlement, but that is in the rear-view mirror. We see the challenges driven more by increased competition than economic conditions or a “drop off in Covid-related sales.”
CEO Rosalind Brewer said the company will increase its cost-cutting initiative to $4.1 billion and take other steps to increase profitability in its health care segment, but with Amazon (AMZN $127) Pharmacy gaining momentum, and multiline retailers like Target (TGT $134) and Walmart (WMT $155) increasing market share, will that be enough? We don’t think so. Even at a thirteen-year low, the share price doesn’t look that attractive. It is going to take an intelligent strategic initiative to garner our interest once more, and we don’t see management bringing anything like that to the table.
We closed Walgreens from the Penn Global Leaders Club at $36 per share in November 2020. Up until that point, it had been a staple company in the portfolio.
Fr, 23 Jun 2023
Restaurants
The Cava IPO proves that (too) many haven’t gotten any smarter since the downturn
It felt like the old days; the New York Stock Exchange was all abuzz about a new IPO. Cava Group (CAVA $40), owner of CAVA Mediterranean restaurants and Zoe’s Kitchen, which the company bought back in 2018 and has been converting to CAVA locations ever since, was going public. How exciting. Never mind the fact that Zoe’s was publicly traded between 2014 and 2018 before agreeing to be bought out at a value below its IPO price, this time is different.
With the IPO priced at $22 per share for the Mr. Howells and Daddy Warbucks of the world, by the time us hoi polloi had a chance to buy in at the open the price had doubled—topping out at $47.89 within hours. Unlike Airbnb (ABNB $125) or CrowdStrike Holdings (CRWD $144), however, we weren’t the least bit bummed out that we weren’t part of the trading elite.
It seems as though the only carrot much of the investment community needs is a good story to forget their meme stock, crypto, and NFT losses, and pundits quickly offered them one: CAVA was going to be the next Chipotle (CMG $2,045). Cha-ching! Why let discounted cash flow models or actual profits get in the way of a good story? At least with respect to this IPO, it feels like the frothy days of a few years ago. Let the dumb money chase the flashy stories; we still see many unloved bargains sitting out there for astute and selective investors.
This is no disparagement of CAVA; in fact, we want to try the place now. However, investors who bought in on day one or who will buy in anywhere above the IPO price will lose on this one. Think Sweetgreen (SG $11), not Chipotle.
Fr, 23 Jun 2023
Aerospace & Defense
When your company is a perennial money loser, is it wise to go on strike?
That is a rhetorical question. Spirit AeroSystems (SPR $27), which was spun out of Boeing (BA $203) in 2005, designs and manufactures aerostructures—primarily fuselages—for commercial and military aircraft. Boeing and Airbus (EADSY $34) are the company’s two primary customers, with the former generating 80% of the firm’s revenue. In fact, the supplier is responsible for a majority of the Boeing 737’s airframe. The company lost $761 million over the trailing twelve months, $539 million in 2022, $555 million in 2021, and $1.1 billion in 2020. Unionized workers at Spirit just voted overwhelmingly to reject the company’s “best and final offer” and go on strike.
Analysts had considered the company’s last offer “steep but necessary,” as the industry faces mounting challenges even without a strike threat on the table. Spirit offered a 16% pay hike over four years, a $7,500 signing bonus, cost of living adjustments, and annual bonuses—adding up to an aggregate 34% increase over four years. An offer so generous that the the International Association of Machinists and Aerospace Workers (IAM) representatives at the bargaining table recommended its acceptance. At the vote, 79% of union workers rejected the offer, and 85% formally voted to go on strike. Spirit immediately told the organized workers not to report back to work for their shifts on the 22nd of June.
Shares of Spirit and Boeing fell sharply on the rejection, while Airbus shares remained largely unaffected.
Spirit has been losing money for three straight years; this type of manufacturing environment is ready-made for automation and a robotic workforce. The actions belie logic. As for Boeing, we wouldn’t consider touching the shares until their inept CEO, David Calhoun, and most of the board are shown the door.
Tu, 13 Jun 2023
Automotive
Tesla strikes deal with both Ford and GM for use of its Supercharger network
Over a decade ago, EV leader Tesla (TSLA $250) introduced its Supercharger network to overcome buyer angst over hitting the highways in an electric vehicle. In typical Tesla fashion, the company invited other American automakers to adopt their charging methods (NACS, or North American Charging Standard) to help grow the industry. They were rebuffed in a not-so-polite manner. Now, after a decade of Tesla dominance in the EV race, the competition’s haughty attitude has changed.
Drivers of non-Tesla EVs have been forced to use a rather spotty and unreliable system known as CCS, or Combined Charging System. With Ford (F $14) and GM (GM $37) planning on producing millions of electric vehicles per year, this condition has become unacceptable. That is why, over the course of a few weeks, both automakers have inked deals adopting Tesla’s Supercharger standard. Phase one will involve their vehicles coming equipped with an adapter allowing them to use Tesla’s network. Within a few years, compatible plugs will come standard on the vehicles.
What does this mean for Tesla? Naysayers argue the move only helps the company’s competitors sell more EVs and catch up to the leader. Baloney. What it really means is a great new source of revenue as Ford and GM vehicles roll up and plug in. It also highlights the leadership of Tesla within the industry. Tesla’s senior director of charging infrastructure, Rebecca Tinucci, reiterated the company’s mission to “accelerate the world’s transition to sustainable energy.” These new deals will help with that acceleration.
Tesla currently operates 45,000 Superchargers at over 5,000 locations, and the company’s pre-fab system means a new station can be up and running within eight days. Expect the explosive growth of these locations to continue until they are virtually everywhere on American roads. We own Tesla, which is up 103% year-to-date as of this writing, in the Penn New Frontier Fund.
Th, 08 Jun 2023
Economics: Work & Pay
The latest jobless report: another reason the Fed should stop hiking
The number of Americans who applied for unemployment benefits in early June spiked to 261,000, matching July 2022 figures and representing the highest rate since November 2021. The four-week moving average rose to 237,250, and we expect to see that average continue to climb in the face of a softening economy. While that’s bad news for workers, it is good news for those wishing the Fed would finally end its rate hike cycle, and for Americans looking for lower prices at the pump and in the grocery stores.
While the Labor Department didn’t cite specifics for the unexpected jump, the breakdown is interesting: Out of 53 states and territories 26 showed a decrease in claims, 27 had an increase, and two states—California and Ohio—saw a surge in claims. All of the tech layoffs almost certainly accounted for California’s job losses, in addition to companies exiting the state. Rising claims are a leading economic indicator for the economy and often a telltale sign we are nearing a recession. That said, other indicators—such as corporate earnings—point to a quite mild recession, assuming we have one at all.
Thanks to his hawkish—and quite unnecessary—recent comments, most analysts believe we will see another rate hike in July. We have changed our tune (thanks to Powell's rhetoric) and agree with that prediction. After either one or two more hikes, we see an elongated pause going well into 2024. We view the 5% federal funds rate as the sweet spot: not high enough to hurt the US economy, but robust enough to provide cash-starved investors with some real yield for the first time in a decade. Sadly, Powell doesn't want to seem to stop his tightening.
As for fixed-income maturities, we are moving out our duration sweet spot to 5-7 years. We will continue to buy on the shorter end as well, but now feel comfortable walking up a few more steps on the duration ladder.
Mo, 05 Jun 2023
South Asia
The expulsion of each other's journalists is just the latest flashpoint in the deteriorating relations between India and China
"The enemy of my enemy is my friend?" Sadly, considering India's tight relationship with Russia's Putin, that saying doesn't really apply with respect to India's ongoing Cold War (which is, at times, hot) with China, but it is fascinating to watch from a distance.
The latest flare-up comes after each country kicked out the other's journalists, with India denying visa renewals to Chinese state media personnel, and China quickly reciprocating. Tensions between the two neighbors, which share a 2,100-mile border, have been steadily growing over the past several years, marked by border conflicts and economic disputes.
Not long after the Chinese-borne pandemic began, a deadly clash took place in the Himalayan Mountains along a stretch of land claimed by both countries; specifically, the Aksai Chin region. Twenty Indian soldiers and an unknown number of Chinese troops were killed in the fighting, marking the lowest point in relations between the two countries in decades. According to a senior Indian military official, several of the soldiers were killed by clubs embedded with nails.
It doesn't take much for a hyper-sensitive China, emboldened by a growing economy, to react violently to perceived threats. In addition to aggressive behavior along the Indian border, the country has claimed a number of disputed islands in the South China Sea as its own, alienating southern and eastern neighbors in the region.
The CCP has also expressed outrage at the existence of the Quadrilateral Security Dialogue, a geopolitical group made up of the United States, Japan, India, and Australia. It claims the group's purpose is to encircle and isolate the country, though the stated goal of the Quad, as it is known, is to monitor illegal fishing, maritime militias, and the secret shipping of goods such as weapons.
China's inferiority complex with respect to its role on the world stage is troubling. The more it feels slighted, the more the country's military is apt to act in an irresponsible way, as highlighted by the recent border dispute. Unfortunately, India's close relationship with Russia illustrates the nuanced approach the US must take when forming strategic alliances in the region.
As China's economy matures, it will become impossible to maintain the high growth rate it displayed as an emerging market. The arrogance of the country's ruling class will prevent them from accepting that fact, which will lead to ever-growing tumult in the region. For the international portion of any investment portfolio, we see greener pastures outside of both China and India.
Mo, 05 Jun 2023
Leisure Equipment, Products, and Facilities
BofA: Reiterate bullish views on Topgolf Callaway
After meeting with senior executives, Bank of America reiterated its bullish outlook on Penn member (Intrepid Trading Platform) Topgolf Callaway (MODG $19). Analysts were especially impressed with Project PIE, the company's new digital bay inventory system, which should greatly increase the utilization rate at Topgolf—the unit responsible for 39% of sales. We have a $30 per share price target on MODG.
Headlines for the Month of May, 2023
Fr, 19 May 2023
Multiline Retail
Theft, plain and simple: Target expects over $1 billion worth of shrinkage this year
It is a sad testament to our society. Crimes being committed while the justice system looks the other way. Retailer Target (TGT $161) said it lost $763 million last fiscal year due to shrinkage, which is an industry term for the theft of goods. What’s more, the company expects that figure to increase by $500 million this year, bringing the total loss to over $1.2 billion. For a retailer which earned $2.8 billion in net income on $108 billion in sales over the trailing twelve months, that figure is substantial.
And Target is certainly not the only firm facing this problem. The National Retail Federation said that nearly $100 billion worth of goods were stolen in 2021, with the number of violent incidents on the rise. Target is battling the problem by installing more “protective fixtures” in its stores, which means inconvenience for paying customers. We were taken aback the first time we went into a CVS to buy shave blades, only to find them locked behind a plexiglass cover. Expect more items to be protected from theft in this manner. Also expect companies to continue closing locations in high-theft areas, meaning local residents will have to drive further to do their shopping.
Where there is a problem, there is also opportunity. Privately held OpenEye offers its OpenEye Web Services (OWS) system to clients to deter theft, reduce internal fraud, and generate valuable business intelligence for retail stores nationwide. Expect the rapid rise of AI to play a major role in theft prevention, with security companies rushing to apply the emerging technology to solutions for retailers. AI systems can be placed near checkout stands to account for every product in a customer’s possession. New Amazon (AMZN $118) Go convenience stores use advanced technology to scan all items in a cart and charge the customer automatically, negating the need for a checkout stand. Expect more retailers to adopt this technology within the next few years.
In an ideal world, all individuals would have the moral fiber required to not commit these crimes. As we don’t live in such a world, opportunities will be plentiful for creative security technology firms developing solutions for frustrated retailers.
Expect a slew of AI companies to go public over the next twelve to eighteen months; many of which will provide retail security solutions. In the meantime, our favorite pure automation company is Rockwell Automation (ROK $280), which provides intelligent devices and software to business clients, as well as consulting services. We own Rockwell in the Penn New Frontier Fund. For an interesting read on Amazon Go’s “just walk out” AI technology, visit here.
Mo, 15 May 2023
Capital Markets
The hunter becomes the prey: Icahn Enterprises falls 44% on short seller attack
We typically are about as much fans of short sellers as we are those bums who walk up to the “don’t come/don’t pass” line on the craps table. Get the pitchforks out. But now that Nathan Anderson has launched blistering attacks against both Jack Dorsey and Carl Icahn, we are quickly becoming admirers of his Hindenburg “forensic financial research firm.”
The attack on Icahn is poetic. Here is a man who bled TWA dry in the early 1990s, often attacks companies we love, and seemingly ignores the ones in true need of an overhaul. He doesn’t make companies better; he strips them of their value and leaves them for dead—along with their investors’ capital (in our humble opinion).
As for the Hindenburg attack, it is epic. The company’s report, entitled “The corporate raider throwing stones from his glass house,” likened Ichan’s company to a Ponzi scheme, able to survive only by getting new dupes, er, investors in at the bottom of the pyramid. Gutsy accusations against a man who has countless attack dog lawyers on speed dial. Icahn Enterprises LP (IEP $36) suffered its worst-ever day following the report, falling 20%. Icahn and his son own around 85% of the firm, which is now valued at $12 billion.
One particular focus of the report was a margin loan taken out by Icahn and backed by his ownership of IEP. This loan—or the lack of accounting for it—seemingly inflated the raider’s wealth by over $7 billion. When the loan and the market drop of IEP were taken into account, Icahn dropped from the 58th-wealthiest person in the world to the 119th.
Icahn’s response to the Hindenburg attack was two-pronged. He called the report “self-serving” and “generated simply to allow the company to profit from its short position on IEP shares.” He also changed his questionable practice of issuing dividends in the form of additional shares of stock, with 85% going to him and his son. The company declared a dividend distribution of $2 per unit for the first quarter of the year, giving holders the right to elect either a cash option or additional units.
IEP gives investors exposure to Icahn’s personal portfolio of public and private companies in a wide range of industries, from energy to automotive to real estate. Over the past decade, an investment in IEP would have resulted in a 57% unrealized loss for shareholders.
Icahn isn’t about making companies better; he is about financial engineering. Wise investors would steer clear of this limited partnership.
Tu, 09 May 2023
IT Software & Services
Palantir shares soar 25% after strong earnings report, new AI tool announcement
Super-secretive data mining company Palantir (PLTR $10) saw its shares rise 25% following two announcements: quarterly earnings beat estimates and the firm is launching a major new artificial intelligence platform.
As for the first-quarter earnings report, revenue came in at $525 million, an 18% jump over Q1 of 2022, while GAAP net income hit $17 million—the second quarter in a row of GAAP profitability. CEO Alex Karp told shareholders he is confident the company will remain profitable “each quarter throughout the end of the year.” Adjusted income from operations came in at $125 million, well ahead of management’s projections for $91 million to $95 million. Government revenue rose 20% year-on-year, while commercial revenue—a major strategic focus—rose 39% from the previous quarter (15% year-on-year).
Those figures should have been enough to give PLTR shares a nice bump, but the exciting news came with the announcement of the company’s new AI tool, dubbed “AIP,” or AI Platform. Karp said he hasn’t seen demand like this (for a new product) in his twenty years at the company. Imagine a battlefield commander able to access a tool which displays and analyzes intel on enemy targets, identifies potentially hostile situations, proposes battle plans, and sends those plans to combatants in the field for execution. If not revolutionary, it is certainly an enormous evolutionary step.
AIP isn’t just for the military, however. Imagine the manager of a major shipping warehouse which lies in the path of a hurricane. Using private company data, AIP can analyze distribution at the warehouse for areas which are most likely to be affected, decide whether to expedite, delay, or cancel orders, and forecast the impact to revenues based on likely scenarios. All without writing one line of code. Karp says that within days of having the tool, customers will be able to build their own “collaborative AI agent.” The potential is staggering. Investors seemed to agree.
We have owned Palantir in the New Frontier Fund since its IPO and have no intention of selling it when it hits (again) our first target price of $20/share. This is an exceptional company unmatched in its critically important industry.
Mo, 08 May 2023
Transportation Infrastructure
Penn member Uber’s most excellent quarter
We have been big believers in transportation infrastructure company Uber (UBER $38) from its early days, even while analysts were throwing the company under the bus. We were undeterred by various government agencies’ attacks, arguments that competitors would eat away at market share, and two sizeable downturns in its share price. The company’s latest earnings report was what we expected: Uber delivered a beat on both revenue and earnings.
The company generated revenue of $8.82 billion in the first quarter, a 33% jump from Q1 of the previous year, and gross bookings rose 22%, to $31.4 billion. Adjusted EBITDA rose to $761 million (beating the company’s own guidance of $660M to $700M) and should rise as high as $850 million in the second quarter. Shares spiked 11% on the report.
The Mobility segment (ride-hailing) led the first-quarter charge, with gross bookings climbing 43%, while Delivery gross bookings were up 12%. The Freight division, which the company is considering spinning off or selling, was the laggard, with gross bookings down 23%. Uber’s network effect continues to gain momentum at the expense of the competition, chiefly Lyft (LYFT $9), and the company’s total addressable market points to strong growth ahead. Uber currently controls about one-third of the global ride-sharing market, and its food delivery service—currently 40% of revenue—should be a major growth driver going forward.
We maintain our $70 target price on Uber, a member of the Penn New Frontier Fund. That would represent an 85% share price increase from here, even after the post-earnings bump.
Tu, 02 May 2023
Education & Training Services
Shares of education services company Chegg are nearly halved after earnings report
One year ago, almost to the day, we wrote about the market’s irrational response to education services company Chegg’s (CHGG $9) quarterly earnings report. On that day, despite beating on the top and bottom line, the company’s shares were plummeting. That had nothing to do with the quarterly results and everything to do with management’s dour guidance. As we write this, it is déjà vu all over again.
As the session opened following Chegg’s after-market report, shares were cut nearly in half, falling from $17.60 to as low as $8.72. Once again, the company beat expectations on the top ($187.6M revs) and bottom ($2.2M net income) lines. Once again, it was management’s post-report commentary which sank the shares.
Chegg is an online educational resource for students, providing digital and physical textbook rentals, online tutoring, 24/7 homework help, and other student services. The company has “sticky” revenue, in that it charges students a monthly fee (starting at $15.95/mo) for access. With nearly ten million subscribers, the math looks pretty good. Unfortunately, CEO Dan Rosensweig sees a major challenge to the company’s revenue stream on the horizon: AI. Specifically, he sees more students turning to ChatGPT for homework help, which eats directly into Chegg’s core business. In fact, he specifically stated that the artificial intelligence chatbot will have “a direct impact on our new customer growth rate.”
Chegg was a $15 billion company just two years ago; it now has a market cap of $1.1 billion. With a strong business model and a single-digit multiple, it should be fine going forward, but it is not for the faint-of-heart investor.
The average price target among analysts who cover this company is $18.67 per share, though many may amend those targets down following this recent bloodbath. ValueLine has an 18-month price target band between $13 and $51 per share, while Morningstar gives the company a fair value of $28.13 per share. The price swings have been too crazy for us to touch the company right now. That said, we both like the Chegg business model and believe the AI hype is being overplayed—at least with respect to its near-term disruptive power.
Fr, 19 May 2023
Multiline Retail
Theft, plain and simple: Target expects over $1 billion worth of shrinkage this year
It is a sad testament to our society. Crimes being committed while the justice system looks the other way. Retailer Target (TGT $161) said it lost $763 million last fiscal year due to shrinkage, which is an industry term for the theft of goods. What’s more, the company expects that figure to increase by $500 million this year, bringing the total loss to over $1.2 billion. For a retailer which earned $2.8 billion in net income on $108 billion in sales over the trailing twelve months, that figure is substantial.
And Target is certainly not the only firm facing this problem. The National Retail Federation said that nearly $100 billion worth of goods were stolen in 2021, with the number of violent incidents on the rise. Target is battling the problem by installing more “protective fixtures” in its stores, which means inconvenience for paying customers. We were taken aback the first time we went into a CVS to buy shave blades, only to find them locked behind a plexiglass cover. Expect more items to be protected from theft in this manner. Also expect companies to continue closing locations in high-theft areas, meaning local residents will have to drive further to do their shopping.
Where there is a problem, there is also opportunity. Privately held OpenEye offers its OpenEye Web Services (OWS) system to clients to deter theft, reduce internal fraud, and generate valuable business intelligence for retail stores nationwide. Expect the rapid rise of AI to play a major role in theft prevention, with security companies rushing to apply the emerging technology to solutions for retailers. AI systems can be placed near checkout stands to account for every product in a customer’s possession. New Amazon (AMZN $118) Go convenience stores use advanced technology to scan all items in a cart and charge the customer automatically, negating the need for a checkout stand. Expect more retailers to adopt this technology within the next few years.
In an ideal world, all individuals would have the moral fiber required to not commit these crimes. As we don’t live in such a world, opportunities will be plentiful for creative security technology firms developing solutions for frustrated retailers.
Expect a slew of AI companies to go public over the next twelve to eighteen months; many of which will provide retail security solutions. In the meantime, our favorite pure automation company is Rockwell Automation (ROK $280), which provides intelligent devices and software to business clients, as well as consulting services. We own Rockwell in the Penn New Frontier Fund. For an interesting read on Amazon Go’s “just walk out” AI technology, visit here.
Mo, 15 May 2023
Capital Markets
The hunter becomes the prey: Icahn Enterprises falls 44% on short seller attack
We typically are about as much fans of short sellers as we are those bums who walk up to the “don’t come/don’t pass” line on the craps table. Get the pitchforks out. But now that Nathan Anderson has launched blistering attacks against both Jack Dorsey and Carl Icahn, we are quickly becoming admirers of his Hindenburg “forensic financial research firm.”
The attack on Icahn is poetic. Here is a man who bled TWA dry in the early 1990s, often attacks companies we love, and seemingly ignores the ones in true need of an overhaul. He doesn’t make companies better; he strips them of their value and leaves them for dead—along with their investors’ capital (in our humble opinion).
As for the Hindenburg attack, it is epic. The company’s report, entitled “The corporate raider throwing stones from his glass house,” likened Ichan’s company to a Ponzi scheme, able to survive only by getting new dupes, er, investors in at the bottom of the pyramid. Gutsy accusations against a man who has countless attack dog lawyers on speed dial. Icahn Enterprises LP (IEP $36) suffered its worst-ever day following the report, falling 20%. Icahn and his son own around 85% of the firm, which is now valued at $12 billion.
One particular focus of the report was a margin loan taken out by Icahn and backed by his ownership of IEP. This loan—or the lack of accounting for it—seemingly inflated the raider’s wealth by over $7 billion. When the loan and the market drop of IEP were taken into account, Icahn dropped from the 58th-wealthiest person in the world to the 119th.
Icahn’s response to the Hindenburg attack was two-pronged. He called the report “self-serving” and “generated simply to allow the company to profit from its short position on IEP shares.” He also changed his questionable practice of issuing dividends in the form of additional shares of stock, with 85% going to him and his son. The company declared a dividend distribution of $2 per unit for the first quarter of the year, giving holders the right to elect either a cash option or additional units.
IEP gives investors exposure to Icahn’s personal portfolio of public and private companies in a wide range of industries, from energy to automotive to real estate. Over the past decade, an investment in IEP would have resulted in a 57% unrealized loss for shareholders.
Icahn isn’t about making companies better; he is about financial engineering. Wise investors would steer clear of this limited partnership.
Tu, 09 May 2023
IT Software & Services
Palantir shares soar 25% after strong earnings report, new AI tool announcement
Super-secretive data mining company Palantir (PLTR $10) saw its shares rise 25% following two announcements: quarterly earnings beat estimates and the firm is launching a major new artificial intelligence platform.
As for the first-quarter earnings report, revenue came in at $525 million, an 18% jump over Q1 of 2022, while GAAP net income hit $17 million—the second quarter in a row of GAAP profitability. CEO Alex Karp told shareholders he is confident the company will remain profitable “each quarter throughout the end of the year.” Adjusted income from operations came in at $125 million, well ahead of management’s projections for $91 million to $95 million. Government revenue rose 20% year-on-year, while commercial revenue—a major strategic focus—rose 39% from the previous quarter (15% year-on-year).
Those figures should have been enough to give PLTR shares a nice bump, but the exciting news came with the announcement of the company’s new AI tool, dubbed “AIP,” or AI Platform. Karp said he hasn’t seen demand like this (for a new product) in his twenty years at the company. Imagine a battlefield commander able to access a tool which displays and analyzes intel on enemy targets, identifies potentially hostile situations, proposes battle plans, and sends those plans to combatants in the field for execution. If not revolutionary, it is certainly an enormous evolutionary step.
AIP isn’t just for the military, however. Imagine the manager of a major shipping warehouse which lies in the path of a hurricane. Using private company data, AIP can analyze distribution at the warehouse for areas which are most likely to be affected, decide whether to expedite, delay, or cancel orders, and forecast the impact to revenues based on likely scenarios. All without writing one line of code. Karp says that within days of having the tool, customers will be able to build their own “collaborative AI agent.” The potential is staggering. Investors seemed to agree.
We have owned Palantir in the New Frontier Fund since its IPO and have no intention of selling it when it hits (again) our first target price of $20/share. This is an exceptional company unmatched in its critically important industry.
Mo, 08 May 2023
Transportation Infrastructure
Penn member Uber’s most excellent quarter
We have been big believers in transportation infrastructure company Uber (UBER $38) from its early days, even while analysts were throwing the company under the bus. We were undeterred by various government agencies’ attacks, arguments that competitors would eat away at market share, and two sizeable downturns in its share price. The company’s latest earnings report was what we expected: Uber delivered a beat on both revenue and earnings.
The company generated revenue of $8.82 billion in the first quarter, a 33% jump from Q1 of the previous year, and gross bookings rose 22%, to $31.4 billion. Adjusted EBITDA rose to $761 million (beating the company’s own guidance of $660M to $700M) and should rise as high as $850 million in the second quarter. Shares spiked 11% on the report.
The Mobility segment (ride-hailing) led the first-quarter charge, with gross bookings climbing 43%, while Delivery gross bookings were up 12%. The Freight division, which the company is considering spinning off or selling, was the laggard, with gross bookings down 23%. Uber’s network effect continues to gain momentum at the expense of the competition, chiefly Lyft (LYFT $9), and the company’s total addressable market points to strong growth ahead. Uber currently controls about one-third of the global ride-sharing market, and its food delivery service—currently 40% of revenue—should be a major growth driver going forward.
We maintain our $70 target price on Uber, a member of the Penn New Frontier Fund. That would represent an 85% share price increase from here, even after the post-earnings bump.
Tu, 02 May 2023
Education & Training Services
Shares of education services company Chegg are nearly halved after earnings report
One year ago, almost to the day, we wrote about the market’s irrational response to education services company Chegg’s (CHGG $9) quarterly earnings report. On that day, despite beating on the top and bottom line, the company’s shares were plummeting. That had nothing to do with the quarterly results and everything to do with management’s dour guidance. As we write this, it is déjà vu all over again.
As the session opened following Chegg’s after-market report, shares were cut nearly in half, falling from $17.60 to as low as $8.72. Once again, the company beat expectations on the top ($187.6M revs) and bottom ($2.2M net income) lines. Once again, it was management’s post-report commentary which sank the shares.
Chegg is an online educational resource for students, providing digital and physical textbook rentals, online tutoring, 24/7 homework help, and other student services. The company has “sticky” revenue, in that it charges students a monthly fee (starting at $15.95/mo) for access. With nearly ten million subscribers, the math looks pretty good. Unfortunately, CEO Dan Rosensweig sees a major challenge to the company’s revenue stream on the horizon: AI. Specifically, he sees more students turning to ChatGPT for homework help, which eats directly into Chegg’s core business. In fact, he specifically stated that the artificial intelligence chatbot will have “a direct impact on our new customer growth rate.”
Chegg was a $15 billion company just two years ago; it now has a market cap of $1.1 billion. With a strong business model and a single-digit multiple, it should be fine going forward, but it is not for the faint-of-heart investor.
The average price target among analysts who cover this company is $18.67 per share, though many may amend those targets down following this recent bloodbath. ValueLine has an 18-month price target band between $13 and $51 per share, while Morningstar gives the company a fair value of $28.13 per share. The price swings have been too crazy for us to touch the company right now. That said, we both like the Chegg business model and believe the AI hype is being overplayed—at least with respect to its near-term disruptive power.
Headlines for the Month of April, 2023
We, 26 Apr 2023
Personal Finance
SECURE 2.0 added an interesting twist to the 529 college savings plan
The SECURE 2.0 Act of 2022 brought some 92 provisions to the way Americans save for retirement. While a few high-profile changes made the headlines, a little digging led to an obscure change to the popular 529 college savings plan.
The 529 plan, established a generation ago, allows parents or grandparents to put money away to help cover the costs of their kids’ or grandkids’ education—primarily college, but the program later expanded in scope to include primary and secondary education costs. Although contributions are not tax deductible, not only do the funds grow free from taxation, disbursements made for qualified expenses are also tax-free for the entire portion—including growth. If there has been one major issue with the program, it has been the challenge of what to do with any excess funds not used for education by the beneficiary or another qualifying family member. That is about to change.
Until now, if 529 funds were not used for education, any withdrawals would incur a 10% penalty along with full taxation. Beginning in 2024, assuming the plan has been opened for at least fifteen years, tax- and penalty-free distributions can be made to fund a Roth IRA for the beneficiary. As with any IRA, the annual contribution limit must be honored, and the owner of the Roth must have earned income equal or greater than the amount moved. For example, if a beneficiary made $10,000 in earned income, the full $6,500 (based on 2023 limits) annual contribution could be made. If the beneficiary earned $2,000 in income for the year, that would be the maximum qualified to roll over. There is also a $35,000 lifetime cap placed on the aggregate rollovers made from any given plan. If the 529 plan has not been established for fifteen years, that threshold must be simply be met before the rollovers can be made.
We have come a long way with respect to education funding since the days of the $500 max-contribution Education IRAs. With the runaway cost of attending college, it is important to understand all of the options available to avoid—or at least mitigate—decades-long loan payback periods. Financial advisors and planners can help guide you through the maze of options and strategies.
For clients looking at 529 plans or other education savings vehicles for their kids or grandkids, the Education Analysis section of the Personal Financial Website contains some great information regarding funding higher education, to include updated figures for specific schools. Goals can be created, various scenarios can be run, and different strategies can be evaluated. Initial information can be added by going to Profile>Goals>Add Goal>Education. Various scenarios can be run by going to the Education tab and then selecting Action Items. Finally, existing student loans can be evaluated by going to the Dashboard and selecting the Student Loan sub-tab.
Tu, 25 Apr 2023
Metals & Mining
Chile’s radical leftist leader underscores the country risk involved with lithium miners
High-grade lithium is a critical component to the new generation of batteries which are “fueling” the EV movement, and we have outlined some of our favorite lithium miners in the recent past. However, Chile’s leftist president, Gabriel Boric, provides us a glaring reminder of the country risk involved with investing in this industry.
Take Albemarle (ALB $182), the world’s largest lithium miner and an investor darling in the space. This North Carolina-based company (hence, Albemarle) has extensive operations in Chile in the form of salt brine deposits—the source of the mineral—and a major lithium conversion plant. Shares of the company plunged double digits last week after the Chilean leader unveiled plans to create a state-owned lithium company and take a majority stake in private mining companies. That sounds ominously similar to the language we heard out of Venezuela under Chavez and Maduro with respect to private oil operations.
Albemarle’s CEO, Jerry Masters, tried to put a spin on the news, saying that existing mining operations wouldn’t be affected, and that the announcement presents an “opportunity to work with the administration” going forward. Yes, because leftist leaders make such great business partners. The company does have operations in Australia and the United States as well, but we see trouble brewing for their Chilean fields. While Australia is the leading lithium producer in the world, Chile holds the world’s largest known reserves of the mineral.
Our favorite lithium miner is Livent Corp (LTHM $22), which was spun out of FMC in 2018. The company has major mining operations in Argentina as well as conversion plants in the US, Canada, and China. Investors should keep an eye on Tesla (TSLA $161), as we could see the EV leader purchasing a small-cap player in the space over the next year or two. Brazil-based Sigma Lithium (SGML $34) has been a rumored target, but it is more a speculative play.
Mo, 24 Apr 2023
Beverages
What consumer slowdown? Penn member Coca-Cola rocks the quarter
We keep hearing anecdotal stories about how the American consumer is pumping the breaks on discretionary spending, and what’s more discretionary than soda pop? Of course, Coca-Cola (KO $65) sells a lot more than “Coke” these days, owning such brands as BodyArmor, Costa Coffee, Dasani, Minute Maid, and around 200 other brands, but we were still expecting a relatively muted quarter. Instead, the 137-year-old beverage maker gave us a blockbuster.
The company generated $11 billion in revenue, besting last year’s Q1 numbers and beating analyst estimates, and earned $0.68 per share versus estimates of $0.65. Management also reiterated its full-year outlook for growth between 4% and 5% at a time when most other consumer brands are dampening expectations for the remainder of the year. Most impressively, Coke put these numbers together in the face of an 11% average selling price increase during the quarter. So, not only are consumers still buying Coca-Cola products, they are paying more to do so.
Coke has invested heavily in modernizing its supply chain and leveraging its strong bottler relationships in high-growth emerging markets. It has also built an impressive empire of brands, which is paying off in spades around the world. While many investors are looking to add international positions to their portfolio, consider this: Coca-Cola generated 65% of its sales in international markets last year. Costa Coffee alone has some 4,000 retail outlets outside of the United States. While no consumer goods company is completely immune to economic conditions, Coke’s exemplary management team has built an all-weather stalwart.
We added shares of Coca-Cola to the Penn Global Leaders Club during the heart of the pandemic downturn—March of 2020—and it has risen substantially since. Although shares have hit our primary price target of $65, this is precisely the type of firm we wish to own in a choppy economic environment.
Fr, 21 Apr 2023
Media & Entertainment
Netflix is ending its DVD-by-mail business; we didn’t know it was still around
Wow does time ever fly. We were early adopters of Netflix’s (NFLX $322) DVD-by-mail business back in the day, getting rather excited when we opened the mailbox to discover one of little red and white envelopes waiting for us. Could that really have been back in the late 1990s? In this new world of streaming, we just assumed that the service had already been abandoned, but that was not the case—at least until now. During its most recent earnings call, Netflix’s management team announced that it would be mothballing the business that forced Blockbuster—except that one in Bend, Oregon—to shut its doors. Over the past decade, as streaming has taken off, Netflix’s DVD revenue has been steadily declining, from nearly $1 billion a decade ago to under $150 million last year. Those 2022 figures accounted for just 4.5% of the company’s revenue for the year.
While Netflix arguably ushered in the era of streaming, it didn’t get off to a pretty start. We recall being outraged—along with millions of other Americans—back in 2011 when the company split its DVD and streaming services into two separate units, effectively doubling the cost of a subscription from $8 to $16 per month. Investors showed their disdain for the move, driving the share price of NFLX stock down some 80% between summer and the end of the year. In hindsight, that obviously would have been a great time to jump in, as the shares ultimately rose from $9 to $700 between winter of 2011 and winter of 2021—a 7,700% increase if we did our quick math correctly.
Of course, timing is everything. Anyone not selling in December of 2021 at $700 watched as their shares fell to $162 over the ensuing six-month period. And Q1’s earnings report offered investors a mixed bag, at best. Revenue rose a paltry 4% from last year, while Q2’s guidance was weaker than expected. The Street did like two new initiatives, an ad-supported subscription model and a promise to crack down on password sharing, but we are waiting to see subscriber reaction when their kids away at college are no longer able to login (without another subscription). Considering the seemingly perennial rate hikes ($15.49 is the current price of a standard plan), we do like the ad-based $6.99 per month plan, which should widen the company’s subscriber net. According to the company, about 5% of shows available on the standard plan won’t be available on the ad-supported subscription for contractual reasons.
A few more reasons we are steering clear right now are the economic environment and increased competition in the streaming space. Americans don’t want to lose access to their favorite shows, but when household discretionary funds get constricted, turning off the subscription is an easy way to cut down on costs. Especially when nothing would be lost (e.g., recorded programs) like when we change providers.
At $327 per share and with a forward P/E of 30, we believe Netflix shares are fairly valued. Additionally, we see two potential headwinds (as mentioned above) on the immediate horizon: backlash over the password crackdown and a possible recession (job losses are a lagging indicator). While we don’t see a 2011-type meltdown in the share price, we could envision them falling by one-third at some point this year. That would put them in the $220 range, at which time we might be tempted to jump back in. Management has made plenty of missteps over the past quarter century, but the shares have been nothing if not resilient.
Tu, 18 Apr 2023
Commercial Banks
Goldman Sachs bucks the quarterly banking trend with a revenue miss
So far, it has been a pretty good quarter for the big banks. And that makes sense, considering how net interest income should increase as rates rise. That has held true for the likes of JP Morgan, Chase, Citi, Wells Fargo, and Bank of America. Not so much for Goldman Sachs (GS $334), however. The $112 billion global investment bank missed revenue expectations, raking in $12.22 billion as opposed to the $12.76 billion analysts were expecting. In addition to the 5% drop in revenue from the same quarter last year, net income also fell. The bank earned $3.23 billion for the quarter, or 18% less that last year.
A major reason for the miss stems from Goldman’s decision to jettison its Marcus personal loan unit. The fatter margins at the other big banks have been due in good measure to their consumer loans (they have been able to charge higher rates to customers); meanwhile, Goldman has been reducing its exposure to this segment. In addition to ridding itself of Marcus, management announced it would begin the process of selling off its GreenSky unit, a specialty lender it bought just over a year ago. GreenSky was, ironically, designed to be a bolt-on acquisition to Marcus.
Unlike the other big banks, Goldman generates most of its revenue from its Wall Street dealings; understandably, considering higher rates, recession concerns, and the market downturn, this activity has been muted. An area they should have done well in is fixed income, yet they also disappointed in that arena. Fixed income trading revenue dropped 17% from last year, while equity trading revenue fell 7%.
If there was one positive nugget to point to in the quarterly results it was the company’s asset and wealth management division, which notched a 24% revenue increase—to $3.22 billion. But CEO David Solomon’s about face on consumer finance should send up red flags for investors. After all, just a few short years ago they were told that this would be a major catalyst for the company’s growth going forward.
Full disclosure: Not only has Financials been one of our most underweighted sectors over the past two years, we haven’t owned Goldman Sachs for over a decade—and have no plans to add it to any strategy anytime soon. We see little for investors to get excited about here.
Tu, 18 Apr 2023
Energy Exploration & Production
With Exxon Mobil reportedly eyeing the driller, is Pioneer Natural Resources a good buy?
Shares of Scott Sheffield’s Pioneer Natural Resources (PXD $227) spiked last week on reports that $500 billion integrated energy giant Exxon Mobil (XOM $115) had begun informal talks to acquire the E&P firm. Add in the former’s fat dividend yield of 12% and the Saudi’s recent million-barrel-per-day oil cut, and the $53 billion driller becomes worthy of a closer look.
Pioneer works exclusively in the Permian Basin region of West Texas, with average daily production of around 650,000 barrels of oil equivalent (BOE) and 2.2 billion BOE worth of proven reserves. The company’s product mix is approximately 60% oil and 40% natural gas. The impressive 12% dividend yield is a result of management’s objective of returning 80% of operating cash flow minus capital spending back to shareholders. But how likely is an acquisition, and how sustainable is the double-digit yield?
Exxon itself happens to be the fourth-largest driller in the Permian region, and buying Pioneer would allow the company to leapfrog over Occidental Petroleum (OXY $62) to become the largest player. It could also easily fund the acquisition, even with a premium demand from Pioneer: Exxon’s trailing twelve months (TTM) net income is $55 billion, which is still larger than the market cap of Pioneer following the recent price spike. And, unlike Exxon’s rather disastrous 2009 purchase of XTO Energy for $41 billion, Pioneer’s assets are proven, and it operates with industry-leading efficiency.
Two major factors could reduce the firm’s double-digit dividend yield: lower oil prices and increased capital spending. The latter is almost assured, as capex is expected to climb 20% due to inflation and the acquisition of new oil rigs. As for the price of oil, we see it topping out in the mid-$80s range (crude futures sit at $80.68 as of this writing). The company projects it will be able to maintain a $19 per share dividend with WTI near $80, which would equal an 8.3% dividend at current prices.
Whether or not a deal manifests, Pioneer is a solid driller with an enviable balance sheet. Holding just $5 billion worth of debt, the firm’s debt-to-equity ratio is 0.2176, and it holds a cash hoard of $1.2 billion. And for all the lip service being given to renewables, expect the fossil fuel E&P industry to remain strong for years to come.
Investors buying Pioneer to receive a 12% dividend yield will end up being disappointed—it is bound to drop into the single-digit range before long. The price also seems a bit rich to us, especially if the Exxon deal falls through. Our favorite play in the industry is Diamondback Energy (FANG $144), with its dividend yield of 6.6%; one of our least favorite "popular" players is Occidental Petroleum.
Th, 06 Apr 2023
Media & Entertainment
A judge is stopping AMC’s chief financial engineer from performing his latest magic act
As much as we write about AMC Entertainment (AMC $5), it may seem as though we have it out for the Leawood, Kansas-based firm. Not at all. We have it out for the financial engineer posing as a CEO, Adam Aron. Let’s first consider the financials of the theater chain. Take a look at the blue line on the graph below; that line represents shareholder equity, or all of the firm’s assets minus its liabilities. That blue line should never, ever, ever be below zero. AMC has a negative shareholder equity of $2.624 billion and a market cap of $2 billion. For some perspective, the money-losing car company Nikola (NKLA $1.22), which has produced something like 100 vehicles in total, has positive shareholder equity. This leads us to the current scheme of chief Snake Oil Salesman Adam Aron.
Last year we wrote of AMC’s fiendish idea to keep cold, hard cash from entering shareholders’ pockets by issuing preferred shares in lieu of cash for the payment of dividends. These new instruments began trading around the $7 range last summer. As a refresher on preferred stock: it usually comes with a par price of $25 per share and serves up a fat dividend—not used as one. Aron used these preferreds as sweeteners to keep shareholders happy, as they would ultimately be able to convert them to common stock. Not so fast, says a Delaware judge.
In addition to the conversion issue, Aron also wanted a 10-to-1 reverse stock split, which would price AMC common around $50 per share. Delaware Chancery Court Vice Chancellor Morgan Zurn wrote in a letter this week that “the parties offer no good cause to lift the status quo order.” Allowing this plan to proceed, wrote Zurn, would prevent the court from effectively overseeing a class action suit brought about against the chain by the Allegheny County Employees’ Retirement System, which claimed this has all been part of a strategy to dilute the voting power of AMC’s Class A stockholders. You think? The bigger question is why a county pension system would invest in such a speculative stock in the first place?
When the judge’s ruling hit the wires, AMC shares rose double digits while APE shares dropped double digits. APE trades for $1.50 as we write this. Living up to its moniker, shouldn’t this be the catalyst for a new wave of Apesters to jump in? After all, if the judge were to reverse his ruling today, they would be sitting on a 333% gain. Sure, AMC common would immediately drop in price, but it seems fitting to use a little fuzzy math when talking about APE shares.
One of these days, the cult of AMC will end and it will become a normal company once more. Until then, go to the craps table to gamble. Actually, that’s not really a fair comparison—there is a good deal of strategy involved in craps.
Tu, 04 Apr 2023
Space Sciences & Exploration
SPAC meltdown continues: Virgin Orbit goes belly up, is Virgin Galactic next?
In August of 2021 we had a picture of a circus tent on the cover of The Penn Wealth Report. The title of the issue was “This Will Not End Well.” Alongside meme stocks and NFTs was the acronym SPAC, which stands for special purpose acquisition company. It was all the rage back in the summer of ‘21—companies taking the “easy” route to the public markets. As the title indicated, we knew it was just a matter of time before these financial engineering schemes blew up, leaving investors holding the bag. The latest case study comes to us courtesy of Sir Richard Branson’s Virgin Orbit (VORB $0.19).
January 7th of 2022 was a big day for Virgin Orbit. It had recently merged with a SPAC known as NextGen Acquisition Corp II, and executives at the firm were on the floor of the NASDAQ to ring the opening bell. The concept behind the company was unique: instead of launching customer satellites from launch pads, it would load them in a rocket known as LauncherOne which was subsequently loaded on the underbelly of a modified Boeing 747. After the aircraft attained an altitude of around 35,000 feet, the rocket would be released from its pylon and then roar into space. Brilliant idea. Sadly, two of the six missions ended in failure, forcing the company to seek additional funding to stay afloat. After a few potential funding deals fell through, Virgin Orbit executed its final maneuver this week: filing for Chapter 11 Bankruptcy.
So what about Sir Richard’s other SPAC-initiated enterprise, space tourism company Virgin Galactic (SPCE $4)? After rising from $10 per share in its early trading days all the way up to $62.80 per share in February of 2021, the great plunge began (discounting a failed rally back to $52 the following July). That investors turned this into a $14 billion company despite the fact that no space tourists have yet to be launched made us think of the Apple TV show Hello Tomorrow!, in which a slick marketer dupes wide-eyed customers into buying nonexistent homes on the moon. Virgin Galactic’s revenue comes from the sale of tickets to the edge of space with the launch dates coming at some point in the future.
The commercialization of space and the business of space travel will be an incredibly exciting and lucrative undertaking, but investors should do a little reading on the history of failed ventures which took place as Europeans were looking to the New World with visions of riches dancing through their heads. Success will come, but the road will be strewn with many abject failures along the way.
Is there a way to potentially take advantage of the burgeoning commercial space movement today? Yes, but it comes with a high degree of risk. Our favorite play is SpaceX, which we own through The Private Shares Fund—an investment vehicle which owns privately held companies. We are riding a fat profit on our Aerojet Rocketdyne (AJRD $56) position, but that company will soon be acquired near where it currently trades. Another potential investment is Cathy Wood’s ARK Space Exploration & Innovation ETF (ARKX $14), which owns around 35 space-themed companies. Investors should exercise caution and not invest any amount of money in this field they are not willing to lose.
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
We, 26 Apr 2023
Personal Finance
SECURE 2.0 added an interesting twist to the 529 college savings plan
The SECURE 2.0 Act of 2022 brought some 92 provisions to the way Americans save for retirement. While a few high-profile changes made the headlines, a little digging led to an obscure change to the popular 529 college savings plan.
The 529 plan, established a generation ago, allows parents or grandparents to put money away to help cover the costs of their kids’ or grandkids’ education—primarily college, but the program later expanded in scope to include primary and secondary education costs. Although contributions are not tax deductible, not only do the funds grow free from taxation, disbursements made for qualified expenses are also tax-free for the entire portion—including growth. If there has been one major issue with the program, it has been the challenge of what to do with any excess funds not used for education by the beneficiary or another qualifying family member. That is about to change.
Until now, if 529 funds were not used for education, any withdrawals would incur a 10% penalty along with full taxation. Beginning in 2024, assuming the plan has been opened for at least fifteen years, tax- and penalty-free distributions can be made to fund a Roth IRA for the beneficiary. As with any IRA, the annual contribution limit must be honored, and the owner of the Roth must have earned income equal or greater than the amount moved. For example, if a beneficiary made $10,000 in earned income, the full $6,500 (based on 2023 limits) annual contribution could be made. If the beneficiary earned $2,000 in income for the year, that would be the maximum qualified to roll over. There is also a $35,000 lifetime cap placed on the aggregate rollovers made from any given plan. If the 529 plan has not been established for fifteen years, that threshold must be simply be met before the rollovers can be made.
We have come a long way with respect to education funding since the days of the $500 max-contribution Education IRAs. With the runaway cost of attending college, it is important to understand all of the options available to avoid—or at least mitigate—decades-long loan payback periods. Financial advisors and planners can help guide you through the maze of options and strategies.
For clients looking at 529 plans or other education savings vehicles for their kids or grandkids, the Education Analysis section of the Personal Financial Website contains some great information regarding funding higher education, to include updated figures for specific schools. Goals can be created, various scenarios can be run, and different strategies can be evaluated. Initial information can be added by going to Profile>Goals>Add Goal>Education. Various scenarios can be run by going to the Education tab and then selecting Action Items. Finally, existing student loans can be evaluated by going to the Dashboard and selecting the Student Loan sub-tab.
Tu, 25 Apr 2023
Metals & Mining
Chile’s radical leftist leader underscores the country risk involved with lithium miners
High-grade lithium is a critical component to the new generation of batteries which are “fueling” the EV movement, and we have outlined some of our favorite lithium miners in the recent past. However, Chile’s leftist president, Gabriel Boric, provides us a glaring reminder of the country risk involved with investing in this industry.
Take Albemarle (ALB $182), the world’s largest lithium miner and an investor darling in the space. This North Carolina-based company (hence, Albemarle) has extensive operations in Chile in the form of salt brine deposits—the source of the mineral—and a major lithium conversion plant. Shares of the company plunged double digits last week after the Chilean leader unveiled plans to create a state-owned lithium company and take a majority stake in private mining companies. That sounds ominously similar to the language we heard out of Venezuela under Chavez and Maduro with respect to private oil operations.
Albemarle’s CEO, Jerry Masters, tried to put a spin on the news, saying that existing mining operations wouldn’t be affected, and that the announcement presents an “opportunity to work with the administration” going forward. Yes, because leftist leaders make such great business partners. The company does have operations in Australia and the United States as well, but we see trouble brewing for their Chilean fields. While Australia is the leading lithium producer in the world, Chile holds the world’s largest known reserves of the mineral.
Our favorite lithium miner is Livent Corp (LTHM $22), which was spun out of FMC in 2018. The company has major mining operations in Argentina as well as conversion plants in the US, Canada, and China. Investors should keep an eye on Tesla (TSLA $161), as we could see the EV leader purchasing a small-cap player in the space over the next year or two. Brazil-based Sigma Lithium (SGML $34) has been a rumored target, but it is more a speculative play.
Mo, 24 Apr 2023
Beverages
What consumer slowdown? Penn member Coca-Cola rocks the quarter
We keep hearing anecdotal stories about how the American consumer is pumping the breaks on discretionary spending, and what’s more discretionary than soda pop? Of course, Coca-Cola (KO $65) sells a lot more than “Coke” these days, owning such brands as BodyArmor, Costa Coffee, Dasani, Minute Maid, and around 200 other brands, but we were still expecting a relatively muted quarter. Instead, the 137-year-old beverage maker gave us a blockbuster.
The company generated $11 billion in revenue, besting last year’s Q1 numbers and beating analyst estimates, and earned $0.68 per share versus estimates of $0.65. Management also reiterated its full-year outlook for growth between 4% and 5% at a time when most other consumer brands are dampening expectations for the remainder of the year. Most impressively, Coke put these numbers together in the face of an 11% average selling price increase during the quarter. So, not only are consumers still buying Coca-Cola products, they are paying more to do so.
Coke has invested heavily in modernizing its supply chain and leveraging its strong bottler relationships in high-growth emerging markets. It has also built an impressive empire of brands, which is paying off in spades around the world. While many investors are looking to add international positions to their portfolio, consider this: Coca-Cola generated 65% of its sales in international markets last year. Costa Coffee alone has some 4,000 retail outlets outside of the United States. While no consumer goods company is completely immune to economic conditions, Coke’s exemplary management team has built an all-weather stalwart.
We added shares of Coca-Cola to the Penn Global Leaders Club during the heart of the pandemic downturn—March of 2020—and it has risen substantially since. Although shares have hit our primary price target of $65, this is precisely the type of firm we wish to own in a choppy economic environment.
Fr, 21 Apr 2023
Media & Entertainment
Netflix is ending its DVD-by-mail business; we didn’t know it was still around
Wow does time ever fly. We were early adopters of Netflix’s (NFLX $322) DVD-by-mail business back in the day, getting rather excited when we opened the mailbox to discover one of little red and white envelopes waiting for us. Could that really have been back in the late 1990s? In this new world of streaming, we just assumed that the service had already been abandoned, but that was not the case—at least until now. During its most recent earnings call, Netflix’s management team announced that it would be mothballing the business that forced Blockbuster—except that one in Bend, Oregon—to shut its doors. Over the past decade, as streaming has taken off, Netflix’s DVD revenue has been steadily declining, from nearly $1 billion a decade ago to under $150 million last year. Those 2022 figures accounted for just 4.5% of the company’s revenue for the year.
While Netflix arguably ushered in the era of streaming, it didn’t get off to a pretty start. We recall being outraged—along with millions of other Americans—back in 2011 when the company split its DVD and streaming services into two separate units, effectively doubling the cost of a subscription from $8 to $16 per month. Investors showed their disdain for the move, driving the share price of NFLX stock down some 80% between summer and the end of the year. In hindsight, that obviously would have been a great time to jump in, as the shares ultimately rose from $9 to $700 between winter of 2011 and winter of 2021—a 7,700% increase if we did our quick math correctly.
Of course, timing is everything. Anyone not selling in December of 2021 at $700 watched as their shares fell to $162 over the ensuing six-month period. And Q1’s earnings report offered investors a mixed bag, at best. Revenue rose a paltry 4% from last year, while Q2’s guidance was weaker than expected. The Street did like two new initiatives, an ad-supported subscription model and a promise to crack down on password sharing, but we are waiting to see subscriber reaction when their kids away at college are no longer able to login (without another subscription). Considering the seemingly perennial rate hikes ($15.49 is the current price of a standard plan), we do like the ad-based $6.99 per month plan, which should widen the company’s subscriber net. According to the company, about 5% of shows available on the standard plan won’t be available on the ad-supported subscription for contractual reasons.
A few more reasons we are steering clear right now are the economic environment and increased competition in the streaming space. Americans don’t want to lose access to their favorite shows, but when household discretionary funds get constricted, turning off the subscription is an easy way to cut down on costs. Especially when nothing would be lost (e.g., recorded programs) like when we change providers.
At $327 per share and with a forward P/E of 30, we believe Netflix shares are fairly valued. Additionally, we see two potential headwinds (as mentioned above) on the immediate horizon: backlash over the password crackdown and a possible recession (job losses are a lagging indicator). While we don’t see a 2011-type meltdown in the share price, we could envision them falling by one-third at some point this year. That would put them in the $220 range, at which time we might be tempted to jump back in. Management has made plenty of missteps over the past quarter century, but the shares have been nothing if not resilient.
Tu, 18 Apr 2023
Commercial Banks
Goldman Sachs bucks the quarterly banking trend with a revenue miss
So far, it has been a pretty good quarter for the big banks. And that makes sense, considering how net interest income should increase as rates rise. That has held true for the likes of JP Morgan, Chase, Citi, Wells Fargo, and Bank of America. Not so much for Goldman Sachs (GS $334), however. The $112 billion global investment bank missed revenue expectations, raking in $12.22 billion as opposed to the $12.76 billion analysts were expecting. In addition to the 5% drop in revenue from the same quarter last year, net income also fell. The bank earned $3.23 billion for the quarter, or 18% less that last year.
A major reason for the miss stems from Goldman’s decision to jettison its Marcus personal loan unit. The fatter margins at the other big banks have been due in good measure to their consumer loans (they have been able to charge higher rates to customers); meanwhile, Goldman has been reducing its exposure to this segment. In addition to ridding itself of Marcus, management announced it would begin the process of selling off its GreenSky unit, a specialty lender it bought just over a year ago. GreenSky was, ironically, designed to be a bolt-on acquisition to Marcus.
Unlike the other big banks, Goldman generates most of its revenue from its Wall Street dealings; understandably, considering higher rates, recession concerns, and the market downturn, this activity has been muted. An area they should have done well in is fixed income, yet they also disappointed in that arena. Fixed income trading revenue dropped 17% from last year, while equity trading revenue fell 7%.
If there was one positive nugget to point to in the quarterly results it was the company’s asset and wealth management division, which notched a 24% revenue increase—to $3.22 billion. But CEO David Solomon’s about face on consumer finance should send up red flags for investors. After all, just a few short years ago they were told that this would be a major catalyst for the company’s growth going forward.
Full disclosure: Not only has Financials been one of our most underweighted sectors over the past two years, we haven’t owned Goldman Sachs for over a decade—and have no plans to add it to any strategy anytime soon. We see little for investors to get excited about here.
Tu, 18 Apr 2023
Energy Exploration & Production
With Exxon Mobil reportedly eyeing the driller, is Pioneer Natural Resources a good buy?
Shares of Scott Sheffield’s Pioneer Natural Resources (PXD $227) spiked last week on reports that $500 billion integrated energy giant Exxon Mobil (XOM $115) had begun informal talks to acquire the E&P firm. Add in the former’s fat dividend yield of 12% and the Saudi’s recent million-barrel-per-day oil cut, and the $53 billion driller becomes worthy of a closer look.
Pioneer works exclusively in the Permian Basin region of West Texas, with average daily production of around 650,000 barrels of oil equivalent (BOE) and 2.2 billion BOE worth of proven reserves. The company’s product mix is approximately 60% oil and 40% natural gas. The impressive 12% dividend yield is a result of management’s objective of returning 80% of operating cash flow minus capital spending back to shareholders. But how likely is an acquisition, and how sustainable is the double-digit yield?
Exxon itself happens to be the fourth-largest driller in the Permian region, and buying Pioneer would allow the company to leapfrog over Occidental Petroleum (OXY $62) to become the largest player. It could also easily fund the acquisition, even with a premium demand from Pioneer: Exxon’s trailing twelve months (TTM) net income is $55 billion, which is still larger than the market cap of Pioneer following the recent price spike. And, unlike Exxon’s rather disastrous 2009 purchase of XTO Energy for $41 billion, Pioneer’s assets are proven, and it operates with industry-leading efficiency.
Two major factors could reduce the firm’s double-digit dividend yield: lower oil prices and increased capital spending. The latter is almost assured, as capex is expected to climb 20% due to inflation and the acquisition of new oil rigs. As for the price of oil, we see it topping out in the mid-$80s range (crude futures sit at $80.68 as of this writing). The company projects it will be able to maintain a $19 per share dividend with WTI near $80, which would equal an 8.3% dividend at current prices.
Whether or not a deal manifests, Pioneer is a solid driller with an enviable balance sheet. Holding just $5 billion worth of debt, the firm’s debt-to-equity ratio is 0.2176, and it holds a cash hoard of $1.2 billion. And for all the lip service being given to renewables, expect the fossil fuel E&P industry to remain strong for years to come.
Investors buying Pioneer to receive a 12% dividend yield will end up being disappointed—it is bound to drop into the single-digit range before long. The price also seems a bit rich to us, especially if the Exxon deal falls through. Our favorite play in the industry is Diamondback Energy (FANG $144), with its dividend yield of 6.6%; one of our least favorite "popular" players is Occidental Petroleum.
Th, 06 Apr 2023
Media & Entertainment
A judge is stopping AMC’s chief financial engineer from performing his latest magic act
As much as we write about AMC Entertainment (AMC $5), it may seem as though we have it out for the Leawood, Kansas-based firm. Not at all. We have it out for the financial engineer posing as a CEO, Adam Aron. Let’s first consider the financials of the theater chain. Take a look at the blue line on the graph below; that line represents shareholder equity, or all of the firm’s assets minus its liabilities. That blue line should never, ever, ever be below zero. AMC has a negative shareholder equity of $2.624 billion and a market cap of $2 billion. For some perspective, the money-losing car company Nikola (NKLA $1.22), which has produced something like 100 vehicles in total, has positive shareholder equity. This leads us to the current scheme of chief Snake Oil Salesman Adam Aron.
Last year we wrote of AMC’s fiendish idea to keep cold, hard cash from entering shareholders’ pockets by issuing preferred shares in lieu of cash for the payment of dividends. These new instruments began trading around the $7 range last summer. As a refresher on preferred stock: it usually comes with a par price of $25 per share and serves up a fat dividend—not used as one. Aron used these preferreds as sweeteners to keep shareholders happy, as they would ultimately be able to convert them to common stock. Not so fast, says a Delaware judge.
In addition to the conversion issue, Aron also wanted a 10-to-1 reverse stock split, which would price AMC common around $50 per share. Delaware Chancery Court Vice Chancellor Morgan Zurn wrote in a letter this week that “the parties offer no good cause to lift the status quo order.” Allowing this plan to proceed, wrote Zurn, would prevent the court from effectively overseeing a class action suit brought about against the chain by the Allegheny County Employees’ Retirement System, which claimed this has all been part of a strategy to dilute the voting power of AMC’s Class A stockholders. You think? The bigger question is why a county pension system would invest in such a speculative stock in the first place?
When the judge’s ruling hit the wires, AMC shares rose double digits while APE shares dropped double digits. APE trades for $1.50 as we write this. Living up to its moniker, shouldn’t this be the catalyst for a new wave of Apesters to jump in? After all, if the judge were to reverse his ruling today, they would be sitting on a 333% gain. Sure, AMC common would immediately drop in price, but it seems fitting to use a little fuzzy math when talking about APE shares.
One of these days, the cult of AMC will end and it will become a normal company once more. Until then, go to the craps table to gamble. Actually, that’s not really a fair comparison—there is a good deal of strategy involved in craps.
Tu, 04 Apr 2023
Space Sciences & Exploration
SPAC meltdown continues: Virgin Orbit goes belly up, is Virgin Galactic next?
In August of 2021 we had a picture of a circus tent on the cover of The Penn Wealth Report. The title of the issue was “This Will Not End Well.” Alongside meme stocks and NFTs was the acronym SPAC, which stands for special purpose acquisition company. It was all the rage back in the summer of ‘21—companies taking the “easy” route to the public markets. As the title indicated, we knew it was just a matter of time before these financial engineering schemes blew up, leaving investors holding the bag. The latest case study comes to us courtesy of Sir Richard Branson’s Virgin Orbit (VORB $0.19).
January 7th of 2022 was a big day for Virgin Orbit. It had recently merged with a SPAC known as NextGen Acquisition Corp II, and executives at the firm were on the floor of the NASDAQ to ring the opening bell. The concept behind the company was unique: instead of launching customer satellites from launch pads, it would load them in a rocket known as LauncherOne which was subsequently loaded on the underbelly of a modified Boeing 747. After the aircraft attained an altitude of around 35,000 feet, the rocket would be released from its pylon and then roar into space. Brilliant idea. Sadly, two of the six missions ended in failure, forcing the company to seek additional funding to stay afloat. After a few potential funding deals fell through, Virgin Orbit executed its final maneuver this week: filing for Chapter 11 Bankruptcy.
So what about Sir Richard’s other SPAC-initiated enterprise, space tourism company Virgin Galactic (SPCE $4)? After rising from $10 per share in its early trading days all the way up to $62.80 per share in February of 2021, the great plunge began (discounting a failed rally back to $52 the following July). That investors turned this into a $14 billion company despite the fact that no space tourists have yet to be launched made us think of the Apple TV show Hello Tomorrow!, in which a slick marketer dupes wide-eyed customers into buying nonexistent homes on the moon. Virgin Galactic’s revenue comes from the sale of tickets to the edge of space with the launch dates coming at some point in the future.
The commercialization of space and the business of space travel will be an incredibly exciting and lucrative undertaking, but investors should do a little reading on the history of failed ventures which took place as Europeans were looking to the New World with visions of riches dancing through their heads. Success will come, but the road will be strewn with many abject failures along the way.
Is there a way to potentially take advantage of the burgeoning commercial space movement today? Yes, but it comes with a high degree of risk. Our favorite play is SpaceX, which we own through The Private Shares Fund—an investment vehicle which owns privately held companies. We are riding a fat profit on our Aerojet Rocketdyne (AJRD $56) position, but that company will soon be acquired near where it currently trades. Another potential investment is Cathy Wood’s ARK Space Exploration & Innovation ETF (ARKX $14), which owns around 35 space-themed companies. Investors should exercise caution and not invest any amount of money in this field they are not willing to lose.
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
Headlines for the Month of March, 2023
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
Mo, 27 Mar 2023
Energy Commodities
No more excuses: begin refilling the Strategic Petroleum Reserve
With a capacity of 714 million barrels, the Strategic Petroleum Reserve, or SPR, is the world’s largest stockpile of oil. Held in underground tanks in Louisiana and Texas, this Department of Energy-maintained stash was a direct result of the 1973 energy crisis when OPEC labeled the United States a “hostile entity” and embargoed all oil exports to the country. To any American who vividly remembers that time, the current state of the SPR is appalling.
Now sitting at its lowest level since 1983—a time at which our energy needs were much lower—the SPR is just over half full (372 million barrels). Over the course of the past two years, the Biden administration has authorized the release of a staggering 266 million barrels of crude for no strategic reason, simply the tactical reason of lowering the price at the pump. That was never what the program was intended for.
As for refilling the SPR, last October the administration cited high prices and further stated that a program would be put in place to begin refilling the reserve when oil fell into the $67 to $72 per barrel range. It dropped down to that range in the middle of March, leading to the latest round of excuses.
When questioned about the lack of action, Energy Secretary Jennifer Granholm said it would take years to replenish the tanks. All we could think of was Ronald Reagan’s classic response to the argument that his Star Wars program would take decades to implement: “Well, then let’s get started.” Granholm’s response was not exactly Reaganesque: “This year it will be difficult for us to take advantage of this low price.” She laid the blame on Congress and maintenance work being done at two of the four SPR sites. No more excuses; it is time to refill this critical component of America’s energy security.
The Saudis were reportedly irked by Granholm's comments that the administration would not begin refilling the SPR this year, directly leading to the OPEC+ announcement that it would cut 1.1 million barrels per day of production between May and the end of the year. That led to a sudden spike in the price of crude, which now sits at $80.54 per barrel. Complete and utter ineptness directly led to American consumers paying more at the pump. What's next, another massive release from the SPR?
We, 22 Mar 2023 Fed raises rates 25 bps
Fed raises rates 25 basis points, to a range of 4.75%-5% upper limit. Odds say 62% chance of another hike in May (next meeting), but we believe the Fed is done. Markets positive to flat while Powell is giving his briefer. By end of session, Dow falls 530 points because Powell did not indicate rate cuts on the horizon this year. Of course he didn't! Completely irrational markets. The US economy can handle these rates.
Tu, 21 Mar 2023
Consumer Finance
The end of easy money: auto loan rejection rate spikes
If the Fed is still looking for evidence that its tightening policy is working, look no further than the auto market. More and more consumers are being rejected for auto loans, with the 9.1% rate marking the highest level in six years. Furthermore, the trajectory has been steep: last October the rejection rate was 5.8%. Auto loan delinquency rates are also rising, going from roughly 2% at the end of 2021 to nearly 4% at the end of last year.
We never thought the 72-month loan was a good idea; now, with the average new vehicle going for nearly $50,000 and interest rates substantially higher, it may take some borrowers that long to pay off the loans. In fact, according to consumer finance services company Bankrate.com, the average payment for a new vehicle is $716 per month, with nearly one in five buyers paying over $1,000 per month. Not long ago, that was a house payment.
Sticker shock has sent many consumers to the used car lots, but that picture isn’t much rosier. The average used car price is $30,000 (substantially higher in many states), and the lack of new vehicles produced during the first year of the pandemic has added strain to the system. Most buyers prefer a late model used vehicle with under 50,000 miles of wear and tear. Of course, another reason for the dearth of vehicles—and higher used car prices—is the fact that would-be sellers realize they would have to pay a much higher interest rate for their new ride—the same challenge the housing market is facing right now. Perhaps it is time to take another look at the do-it-yourself auto repair retailers.
Eventually, this problem will work itself out. While rates will almost certainly stay higher for longer, the trajectory of inflation in this market is unsustainable. Our favorite used car dealership remains CarMax (KMX $59), which is down 62% from its high share price and trading at a reasonable multiple of seventeen. Our favorite DIY shop is Advance Auto Parts (AAP $120), which has a tiny forward P/E of ten, and a solid customer mix of 60% commercial and 40% consumer clients. By the way, the largest auto finance company is Ally Financial (ALLY $25).
Su, 19 Mar 2023
Bank failures and Fed speculation drove the markets this week
At the end of this frenzied trading week, it was fitting that the only green which would show up on Friday, St. Patrick's Day, was gold—it rose 6% over the course of five days. Rising gold prices are often in response to economic instability and concerns over monetary policy, so the precious metal's surge makes perfect sense.
The week began with news of Signature Bank's collapse, and the only thing standing in the way of a market rout was the government's promise that all depositors at the failed banks would be immediately made whole. The focus quickly turned to what Fed Chair Powell would do at the following week's FOMC meeting. We went from high odds for a 50 bps hike, to calls for an immediate pause while the damage was assessed, to expectations for a 25 bps hike (what we have been—and still are—expecting). Odds increased for the last option when ECB President Christine Lagarde stuck by her guns and raised rates in the EU by 50 bps. Any pause, the pundits argued, would signal fear that the government didn't believe it could contain the new banking crisis.
By late in the week, the domestic banking crisis made its way across the pond to a troubled European institution: Credit Suisse. After the company delayed its annual report and shades of SVB and Signature began gripping investors, the largest shareholder—the Saudi National Bank—said it would not come to the rescue with new funding. On Friday, the Financial Times reported that fellow Swiss bank UBS might be a reluctant suitor (earlier in the week, the $57 billion behemoth said it had little interest in buying the troubled bank). As we write this, UBS has offered $1 billion to take over Credit Suisse, which had a market cap of $35 billion just two years ago and $8 billion at the beginning of the month. Meanwhile, Switzerland is considering nationalizing the firm if the UBS deal fails. Stunning.
Considering everything that happened over the course of five days, it is rather impressive that the benchmarks were relatively unchanged. The NASDAQ, in fact, gained 4.4% on the week. One thing is certain: tech startups which had little trouble securing loans in the zero interest rate environment are going to face much higher hurdles—and debt servicing costs—going forward. Which makes it somewhat strange that the tech-laden benchmark put together a positive week.
The same issues that drove markets this past week will drive them this week: global concerns about the financial strength of middle market and regional banks, and how the Fed will balance battling inflation with these new banking concerns. Expect the Fed's balance sheet reduction program to be placed on pause just as it was beginning to show results.
Mo, 13 Mar 2023
Financial Services
One week, three bank failures; shades of 2008?
We all recall the nightmarish string of bank failures back in 2008 stemming from toxic mortgage-backed securities poisoning the capital of these doomed giants. While we are certainly not at that level of concern right now, the failure of three banks over the course of a few days has the markets on edge.
First came Silvergate Capital (SI $2), the premier lender to the cryptocurrency industry. The California state-chartered bank, which provided financial services such as commercial banking, business lending, and cash management to its customers, sent up red flags when it announced it was closing its Silvergate Exchange Network which served as a bridge between traditional banking services and the crypto world. Then the company said it would not be able to file its required 10-K to the SEC on time. That was all it took for a run on the bank: customers began pulling out some $8 billion worth of deposits, forcing Silvergate to secure a loan from the Home Bank Loan system. Furthermore, the bank was forced to sell the solid assets on its balance sheet such as Treasuries and securitized residential mortgage loans at discount prices to fund the customer withdrawals. These assets were discounted because of the Fed rate hikes—the bank simply didn’t have the luxury of waiting for the securities to mature at par. By late in the week, Silvergate announced it was winding down its operations. Sadly, the story did not end there.
Silicon Valley Bank, the major arm of SVB Financial Group (SVB, trading halted), collapsed on Friday, becoming the second-largest bank failure in US history (Washington Mutual, which failed during the financial crisis, was the largest). The FDIC quickly moved in to take control, creating a new entity called the Deposit Insurance National Bank of Santa Clara. SVB was the 16th largest bank in the country, with around $210 billion in assets, and was the go-to bank for tech startup firms—many of whom wouldn’t have been able to access funding otherwise.
As for cryptocurrency shops, the preferred lender behind Silvergate has been New York-based Signature bank (SBNY, trading halted). On Sunday, regulators closed the doors of this institution, which held nearly $100 billion on deposit. New York Governor Kathy Hochul said this did not amount to a taxpayer bailout, as the funds required to pay back depositors would come from "the fees assessed on all banks." She was referring to the Deposit Insurance Fund, which will guarantee money above and beyond the FDIC limit—or "uninsured" funds.
These closures lead many to wonder why companies would not have better risk management with respect to their deposits, spreading around their money to a number of different financial institutions. For example, streaming device company Roku said it had some $500 million—or 26% of its cash reserves—in an account at SVB. A who’s who list of prominent companies have already announced they are in a similar situation. Per one seasoned venture capitalist, if a tech startup received loans from a bank, that institution pretty much demanded that the bulk of their cash be kept at the firm. Furthermore, tech companies overwhelmingly trusted SVB, Silvergate, and Signature. They simply couldn't believe there would ever be a run on these banks.
In the wake of these meltdowns and with rates much higher rates than a year ago, these tech startups must now be wondering where they can possibly turn for new sources of funding. The troubles in Silicon Valley won't go away with the government's promised backstop.
Two thoughts come to mind. As the interest rate hike cycle began, we were told how this would help the major financial institutions, as their net interest income—the difference between what they could make on loans and what they had to pay on investors’ deposits—would increase greatly. We didn’t buy that argument this time around, and Financial Services remains our most underweighted sector. Second thought: Many experts have been saying for the past several months that the Fed would continue to raise rates until they “broke things.” Mission accomplished. If the hot jobs numbers and the recent inflation reports were pointing to a 50 bps hike at the March meeting, the broken pieces laying on the floor around them should give the Fed pause. We still believe a 25-bps hike will be announced on the 20th, but odds for an immediate pause are growing. And 50 bps is now all but off the table.
Th, 09 Mar 2023
Technology Hardware & Equipment
Exit, stage left: Apple is expediting its move out of China and into India
India just surpassed China as the world’s most populous nation, with 1.412 million citizens, but size is just a minor factor in Apple’s (AAPL $152) hurried exodus out of the communist nation and into the South Asian country. The world’s largest publicly traded company ($2.4 trillion as of this writing) had a rare contraction in sales of 5.5% in the last quarter of 2022 as compared to the prior year, but it posted record revenues in India. Couple that with China’s growing ties to Russia, a continuing Covid nightmare in the country, and saber-rattling against the West (especially the US), and it makes sense that Apple would be packing up, so to speak, and heading west. And where Apple goes, its suppliers are sure to follow.
Key suppliers to the Cupertino-based firm are increasingly being asked one question by their corporate customers: “When can you move out (of China)?” An executive at GoerTek, an AirPods manufacturer, said that 90% of his American tech firm clients are asking that question on a near-constant basis, and the pressure is growing. While Vietnam has been a major destination for many of these firms, India has been building momentum. For the first time ever, Apple has designated India as its own region, as opposed to simply being part of a larger geographic area including Middle Eastern, Eastern European, and African nations. Somewhat surprisingly, Apple still doesn’t have a physical footprint in India via retail outlets, but that will change beginning later this year. Apple recently created an online store dedicated to serving its Indian customers.
In addition to reading the writing on the wall with respect to increasingly strained US-China relations, Apple has faced tumult at its Chinese facilities recently. Late last year, at its massive Foxconn plant in Zhengzhou, violent protests broke out as workers rioted against low pay and Covid restrictions. Up to 85% of iPhone Pros had been produced at that facility. It appears as though Apple is finally getting the message.
Why did it take so long for American companies to wake up to the risks of concentrating operations in a state-controlled country? Quite simply, they were chasing profits and ignoring the obvious threats. A little over a generation ago, Americans could flip over common retail goods and read the “Made in Japan” label. Overwhelmingly, those labels now read “Made in China.” It will take some time to change that, but the exodus has begun—and we don’t see anything on the horizon that will derail the movement.
Tu, 07 Mar 2023
Housing
The Fed is raising rates to cool inflation, but one segment will remain immune
The long-term average 30-year mortgage rate is 7.75%; as of this writing—despite what the accompanying chart shows—we have retaken the 7% level. While 7.75% is the long-term average, the ten-year average mortgage rate sits at 4%; but, for a brief two-year period, we sat in a trench below that level. The typical American may make some poor financial decisions, but a large percentage of the US population did something brilliant over that spell: they either financed a new purchase at rock-bottom rates or they refinanced their existing home with a fixed-rate loan. While 10% of current home loans are the adjustable-rate (ARM) variety, that is well below the historic average (40% of mortgage loans were ARMs back in 2006, for example). For Americans locking in 2.65% to 4% rates, it is time to celebrate. For the Fed, not so much.
The Fed has a dual mandate: keep the unemployment rate reasonably low and keep inflation somewhere around the 2% rate. While the first mandate has obviously been met, the central bank continues to raise rates in an effort to bring down the stubbornly high level of inflation. Were they operating in most other countries (a 30-year fixed-rate home loan is a uniquely American experience), they would be having an easier time. However, the 40% of homeowners who took out those low-rate loans in either 2020 or 2021 are immune from the Fed’s actions—at least with respect to their largest expense. They may be locked into their existing home, but that extra purchasing power will remain intact for decades. Sadly, evidence is mounting that many Americans are once again spending beyond their means: credit card balances just hit a new record high. And for anyone who has looked at their credit card interest rates lately, it is clear that the banks wasted no time in spiking those very-adjustable rates.
With such a large percentage of homeowners locked into their current homes due to low mortgage rates, the housing industry will continue to be negatively impacted. In a warped sense, this is what the Fed wants to see—lower or stagnate home prices due to reduced demand, and higher unemployment in the industry due to a pullback in construction. Investors should keep in mind that the homebuilders reside in the Consumer Discretionary sector; a segment which is already facing headwinds due to the probable recession on the horizon. We have been underweighting this sector since the middle of last year.
Headlines for the Month of February, 2023
Mo, 27 Feb 2023
East/Southeast Asia
Xi tells China’s military establishment to be prepared for Taiwan invasion by 2027
According to CIA Director William Burns, Chinese President Xi Jinping has conveyed a strategic message to the People’s Liberation Army: Be prepared to invade and take control of Taiwan by 2027. To be clear, there is no possible scenario in Xi’s mind in which Taiwan is not fully under the thumb of Beijing. If anyone still believes that they don’t understand the mind of a communist like Xi and the history of Taiwan going back to 1949. Jimmy Carter certainly didn’t understand the mind of a Chinese communist, or he wouldn’t have cut ties with a democratic Taiwan in favor of improved relations with Beijing. But the myopia certainly hasn’t been limited to one party: both sides have been in power as the US became overly reliant on cheap goods and an enormous potential market in the East. Never mind that the Western values of individual liberty and personal freedom are anathema to communism. We wonder if anyone ever believed that the balance of trade between the US and China would be anything other than grossly lopsided?
Now, despite that country’s unwillingness to take any responsibility for the pandemic unleashed on the world, many want us to believe that Xi is sitting back, watching his buddy Putin sink in the quicksand that is Ukraine, and second-guessing his plans to invade Taiwan. He is probably furious at his friend for shining the spotlight on the similarities between Ukraine and Taiwan with respect to their bully neighbors, but he would be sending arms to Russia for use in the conflict right now if the world weren’t watching his actions so closely. Just before the start of the Olympics, Putin promised Xi two things: that he would wait to invade until after the games had concluded, and that war would be swift and victory assured. Xi must be taken aback by both the toughness of the Ukrainian people and the cohesion of the Western world against this horrific act.
The West must now make it clear that we are willing to defend Taiwan (and the president has said as much), and that a swift victory would not be possible. His mind may still be made up, but doubt has crept in—at least about going in before 2027.
Americans should pay attention to where the goods they buy are sourced and also have a basic understanding of the modern geopolitical world. For example, Vietnam has been a major recipient of US manufacturing deals as companies scramble to exit China; Vietnam has strained relations with China and continues to be a growing economic partner to the US. The same could be said of Malaysia, Bangladesh, Taiwan, and India—though the latter has ruffled feathers with its continued purchase of Russian energy. The United States played a major role in China’s economic growth over the past generation. Now, with a full understanding of that nation’s strategic plans, we have the power to impede that growth trajectory. But do we have the stomach for it?
Th, 23 Feb 2023
Metals & Mining
Two catalysts for lithium miners' recent volatility: Tesla and a Chinese battery company
In the mad dash to create more efficient batteries for electric vehicles, few elements, literally, are more important than high-grade lithium. Mining projects to produce this valuable element, however, are costly and can take years to get up and running. These factors should make current lithium miners extremely valuable; and, in fact, a look at the three year returns for the major players shows them far outpacing the performance of their respective benchmark indexes. But last Friday something odd happened: lithium miners got crushed, falling around 10% on average and leaving investors befuddled as to why.
It turns out that two companies on different sides of the planet led to the drop. In China, the world’s largest EV battery maker, Contemporary Amperex Technology (aka CATL), pulled a fast one. Without warning, the company changed its pricing structure on batteries to a lithium-based model, which had the effect of greatly reducing the price it charges per unit. Since CATL produces its own lithium from company-owned mines, it has the ability to reduce profit margins on the input side to virtually nothing—a luxury most EV battery makers don’t have.
With CATL’s actions in mind, it recently came to light that major US electric battery producer Tesla (TSLA $202) may be interested in acquiring mid-cap ($3.6B) miner Sigma Lithium Corp (SGML $35). This Vancouver-based company mines high-purity lithium from its enormous mining operation in Brazil. While the other miners were watching their shares plunge, SGML shares were busy spiking nearly 20%.
While Tesla said that Sigma is but one of many options being considered, it clearly wants to control its own mining operation. For a company with a clear history of vertical integration, the move makes perfect sense. Close to the port city of Corpus Christi, Tesla is in the process of building its own lithium processing plant, scheduled to be up and running by next year. Investors are betting that a company-owned mining firm won’t be far behind. If it doesn’t turn out to be Sigma, however, look for those shares to plunge back to earth.
Yes, Tesla shares have doubled in price since January 6th, but we still consider them a bargain. As for the miners, we prefer industry leader Albermarle (ALB $252, $35B market cap) and small-cap miner Lithium Americas Corp (LAC $23, $3.5B market cap). The latter is developing three new lithium production facilities—two in Argentina and one in Nevada—with the ultimate goal of splitting into two companies based on geography. The need to diversify away the risk of relying on China for critical elements and rare earth minerals has never been more evident, which should provide ample opportunity in the space for astute investors looking closer to home.
Th, 16 Feb 2023
Hotels, Resorts, & Cruise Lines
Airbnb stock soars after its first fully profitable year
On 07 December 2022, just over two months ago, Morgan Stanley downgraded travel services company Airbnb (ABNB $143) and slashed its price target to $80 per share. The shares immediately fell 5% on the news, and we immediately added the company to the Penn Global Leaders Club. We didn’t buy into the analyst’s narrative, but we did buy into CEO Brian Chesky’s intelligent strategic vision for the company. Our initial price target for ABNB shares was $145. Ten weeks later, the shares have moved 56% above our purchase price, and we still consider them a bargain.
The latest catalyst for the move higher was a stellar Q4 earnings report. Revenues rose 24%—to $1.9 billion—from the same period a year earlier, and profits came in nearly double what was expected ($0.48 vs $0.25). Most importantly, after losing $4.6 billion in 2020 (pandemic) and $300 million in 2021, the company just posted its first profitable year, bringing in $2 billion on $8.4 billion in revenue. That equates to an impressive 22.52% operating margin. While others (like Vrbo) enter the business and while the hotels try new tactics to emulate what Airbnb has created, Chesky’s company remains on the cutting edge of new technologies designed to increase its dominance in the space. Meanwhile, Airbnb sits on a $10 billion mountain of cash, a tiny relative debt load of $2 billion, and a demand backlog due to a record number of new bookings. Suddenly, the analysts are changing their tune.
Even though the shares have run up to near our price target in a matter of months, our Global Leaders Club purchases are designed to be longer-term holdings. In other words, we won’t be selling at $145. Airbnb is the only travel-related company we currently own in the Club—the hotels remain a bit too expensive, and the cruise lines (we prefer Royal Caribbean and Norwegian) could be further affected by softening economic conditions.
Tu, 14 Feb 2023
IT Software & Services
Palantir soars after the company announces its first profitable quarter
Shares of data software company and Penn New Frontier Fund member Palantir (PLTR $9) soared double digits after the company reported its first quarterly profit, earning $31 million in Q4. Revenues rose 18% from a year ago, to $509 million, with government revenue jumping 23% and commercial sales growing by 11%. CFO David Glazer said he expects that rate of growth to continue throughout 2023.
Denver-based Palantir aggregates massive amounts of data to produce usable, actionable information for its government and civilian clients. As our favorite example, the company was essential in collecting and analyzing the data which ultimately allowed US forces to track down and kill terrorist Osama bin Laden. Palantir’s customer mix is roughly 60% government and 40% civilian sector, respectively, with 43% of its revenues emanating from outside of the US. As a policy, the company will only deal with nation-states aligned with the values of the United States—no bad actors welcome. With cash on hand of $2.5 billion, Palantir holds no debt on its books.
The company’s three platforms, Palantir Gotham, Palantir Foundry, and Palantir Apollo, are unrivaled in the industry, and we fully expect the firm to maintain its benchmark position. We opened our position in the Penn New Frontier Fund within minutes of its IPO, purchasing shares roughly where they now sit. We maintain our $20 price target on the shares and would not be a seller once that level is reached.
Th, 09 Feb 2023
Media & Entertainment
Bob Iger’s return is already paying dividends for Disney
There was at least one person enamored with former Disney (DIS $116) Ceo Bob Chapek: Bob Chapek. Everyone else, not so much. After nearly three years of floundering under the woeful boss, Bob Iger is back; and, based on the first few months of his well-publicized return, the stock might be as well.
After plunging 44% in 2022, shares of Disney have already rebounded 35% in the first six weeks of 2023, buoyed by a strong earnings report and a $5.5 billion cost-cutting program laid out by Iger. First the numbers: Revenues rose 7.7% from Q1 of 2022, to $23.51 billion, while diluted earnings per share came in at $0.99, beating forecasts of $0.77. Disney+ subs disappointed, with the company losing some 2.4 million subscribers over the course of the quarter, though ESPN+ and Hulu—two Disney units—both gained subscribers. Parks revenue continues to impress, jumping 21% from last year—to $8.74 billion—and beating estimates.
What investors really applauded was Iger’s announced $5.5 billion cost savings plan, with $3 billion of that coming from content cuts. Iger also disclosed a headcount reduction of 7,000, or around 3% of the workforce. All of this apparently appeased activist investor Nelson Peltz of Trian Partners, who declared his proxy fight with the company officially over. Iger understands business and how to deal with activist investors; Chapek would have surely invited—and ultimately lost—this battle. Disney still has a lot of work to do (it has already lost the battle with the state of Florida over ownership of the land on which Walt Disney World sits), but we expect more intelligent leadership out of Iger.
We added Disney back into the Penn Global Leaders Club the same morning Chapek was fired (actually, he was fired over the weekend—to his shock—and we picked up shares at Monday’s open), and the shares are up substantially since that point. Recession or not, we anticipate the parks revenue to continue its post-Covid growth trajectory despite the recent price hikes. Our initial target price for the shares is $150.
Sa, 04 Feb 2023
Week in Review
Bookend bad days didn’t stop the market from plowing ahead this week
The week started off rough, with investors worrying about (potentially) bad earnings reports to come and a Fed which wasn’t prepared to stop raising rates. The latest hike did, indeed, come on Wednesday when Powell and the FOMC announced another 25-basis-point increase, bringing the upper band of target federal funds rate to 4.75%. There seemed to be something different about his press conference this time around, however. His typically hawkish tone seemed a bit mellower, which investors took as a good sign. After being down before and during the rate hike announcement, the market reversed course and finished higher.
Friday brought the real shocker. We are back in bizarro world where good economic news is bad for the markets, and did we ever get some good economic news via the jobs report. Economists were expecting to hear that 187,000 or so jobs had been created in January; the actual number came in at a scorching 517,000 new nonfarm payrolls. The unemployment rate, which many argue needs to be higher for the Fed to pause, dropped to its lowest level since 1969—3.4%. Leisure and hospitality posted huge jobs gains, as did professional and business services, government, and health care. Putting the aggregate number in perspective, it was almost twice as high as December’s strong gain of 260,000 new jobs.
Since the worrisome factor of a strong jobs report is the potential for a wage-price spiral (more people working means more money to spend which means higher prices), all eyes turned to wage growth in the report. For the month of January, wages increased at a 4.4% year-over-year clip. That may seem high, but the number has been steadily coming down since March of last year, and it is inching ever closer to the 2.96% long-term average. As the numbers were digested, they became more palatable. What could have been a lousy finish to the week turned into manageable losses. The only benchmark dropping for the week was the Dow, which only shed fifteen points over the five sessions. Small caps, as measured by the Russell 2000, gained nearly 4% on the week.
There is an old market expression: “As goes January, so goes the year.” We believe that will hold true this year, which would help erase a lot of 2022’s pain. The S&P 500 finished January up 6%, the Russell 2000 was up 10%, and the NASDAQ was up nearly 11%. Bonds, which were down double digits in aggregate last year, are up 3% thus far as represented by the Bloomberg US Aggregate Bond index. So far, so good.
Th, 02 Feb 2023
Energy Commodities
Remember when natural gas was going to be the investment of the decade?
Think back for a minute to last summer. There were a lot of nightmare scenarios dancing around the economic horizon, but few more haunting than Vlad Putin’s desire to make Europeans pay for their support of Ukraine in the war. His number one weapon was energy, and endless stories painted a dire picture of gas bills quadrupling on the continent and many being left without natural gas to heat their homes. For investors, this pointed to an incredible opportunity to invest in the energy commodity using instruments such as UNG ($8.50), the United States Natural Gas ETF.
Indeed, shares of UNG had risen from around $12 going into 2022 to $34.50 by August, a gain of some 187%. And that was during the warm days of summer; imagine (argued investors) how high they might go during the frigid European winter! Fast forward six months. UNG is sitting at $8.50, or 75% lower than it was in August. What happened? A prolonged spell of mild weather on the continent and stronger-than-expected supply inventories have combined to knock natural gas prices back down to pre-war levels. US natural gas production is hitting record highs (we are the world’s largest producer), and US LNG exporters increased shipments to Europe by nearly 150% year-over-year. Europe’s dependence on Russian gas has dropped from over 40% to near zero, yet Putin’s dream of exacting pain has failed to manifest. The pain to be felt in Russia by lost revenue due to his actions, however, is just beginning.
We distinctly remember the copious stories in the financial press about natural gas facilities being knocked offline by storms in the US, the hardship Europeans would face over the winter months, and the critical shortage of LNG. What seemed like a no-brainer of an investment turned into a nightmare for anyone buying into the hype. Yet another great lesson on behavioral finance and the false narratives so prevalent within the media. Always do your homework before investing, and have a specific exit strategy if events don’t play out as expected.
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
Mo, 27 Mar 2023
Energy Commodities
No more excuses: begin refilling the Strategic Petroleum Reserve
With a capacity of 714 million barrels, the Strategic Petroleum Reserve, or SPR, is the world’s largest stockpile of oil. Held in underground tanks in Louisiana and Texas, this Department of Energy-maintained stash was a direct result of the 1973 energy crisis when OPEC labeled the United States a “hostile entity” and embargoed all oil exports to the country. To any American who vividly remembers that time, the current state of the SPR is appalling.
Now sitting at its lowest level since 1983—a time at which our energy needs were much lower—the SPR is just over half full (372 million barrels). Over the course of the past two years, the Biden administration has authorized the release of a staggering 266 million barrels of crude for no strategic reason, simply the tactical reason of lowering the price at the pump. That was never what the program was intended for.
As for refilling the SPR, last October the administration cited high prices and further stated that a program would be put in place to begin refilling the reserve when oil fell into the $67 to $72 per barrel range. It dropped down to that range in the middle of March, leading to the latest round of excuses.
When questioned about the lack of action, Energy Secretary Jennifer Granholm said it would take years to replenish the tanks. All we could think of was Ronald Reagan’s classic response to the argument that his Star Wars program would take decades to implement: “Well, then let’s get started.” Granholm’s response was not exactly Reaganesque: “This year it will be difficult for us to take advantage of this low price.” She laid the blame on Congress and maintenance work being done at two of the four SPR sites. No more excuses; it is time to refill this critical component of America’s energy security.
The Saudis were reportedly irked by Granholm's comments that the administration would not begin refilling the SPR this year, directly leading to the OPEC+ announcement that it would cut 1.1 million barrels per day of production between May and the end of the year. That led to a sudden spike in the price of crude, which now sits at $80.54 per barrel. Complete and utter ineptness directly led to American consumers paying more at the pump. What's next, another massive release from the SPR?
We, 22 Mar 2023 Fed raises rates 25 bps
Fed raises rates 25 basis points, to a range of 4.75%-5% upper limit. Odds say 62% chance of another hike in May (next meeting), but we believe the Fed is done. Markets positive to flat while Powell is giving his briefer. By end of session, Dow falls 530 points because Powell did not indicate rate cuts on the horizon this year. Of course he didn't! Completely irrational markets. The US economy can handle these rates.
Tu, 21 Mar 2023
Consumer Finance
The end of easy money: auto loan rejection rate spikes
If the Fed is still looking for evidence that its tightening policy is working, look no further than the auto market. More and more consumers are being rejected for auto loans, with the 9.1% rate marking the highest level in six years. Furthermore, the trajectory has been steep: last October the rejection rate was 5.8%. Auto loan delinquency rates are also rising, going from roughly 2% at the end of 2021 to nearly 4% at the end of last year.
We never thought the 72-month loan was a good idea; now, with the average new vehicle going for nearly $50,000 and interest rates substantially higher, it may take some borrowers that long to pay off the loans. In fact, according to consumer finance services company Bankrate.com, the average payment for a new vehicle is $716 per month, with nearly one in five buyers paying over $1,000 per month. Not long ago, that was a house payment.
Sticker shock has sent many consumers to the used car lots, but that picture isn’t much rosier. The average used car price is $30,000 (substantially higher in many states), and the lack of new vehicles produced during the first year of the pandemic has added strain to the system. Most buyers prefer a late model used vehicle with under 50,000 miles of wear and tear. Of course, another reason for the dearth of vehicles—and higher used car prices—is the fact that would-be sellers realize they would have to pay a much higher interest rate for their new ride—the same challenge the housing market is facing right now. Perhaps it is time to take another look at the do-it-yourself auto repair retailers.
Eventually, this problem will work itself out. While rates will almost certainly stay higher for longer, the trajectory of inflation in this market is unsustainable. Our favorite used car dealership remains CarMax (KMX $59), which is down 62% from its high share price and trading at a reasonable multiple of seventeen. Our favorite DIY shop is Advance Auto Parts (AAP $120), which has a tiny forward P/E of ten, and a solid customer mix of 60% commercial and 40% consumer clients. By the way, the largest auto finance company is Ally Financial (ALLY $25).
Su, 19 Mar 2023
Bank failures and Fed speculation drove the markets this week
At the end of this frenzied trading week, it was fitting that the only green which would show up on Friday, St. Patrick's Day, was gold—it rose 6% over the course of five days. Rising gold prices are often in response to economic instability and concerns over monetary policy, so the precious metal's surge makes perfect sense.
The week began with news of Signature Bank's collapse, and the only thing standing in the way of a market rout was the government's promise that all depositors at the failed banks would be immediately made whole. The focus quickly turned to what Fed Chair Powell would do at the following week's FOMC meeting. We went from high odds for a 50 bps hike, to calls for an immediate pause while the damage was assessed, to expectations for a 25 bps hike (what we have been—and still are—expecting). Odds increased for the last option when ECB President Christine Lagarde stuck by her guns and raised rates in the EU by 50 bps. Any pause, the pundits argued, would signal fear that the government didn't believe it could contain the new banking crisis.
By late in the week, the domestic banking crisis made its way across the pond to a troubled European institution: Credit Suisse. After the company delayed its annual report and shades of SVB and Signature began gripping investors, the largest shareholder—the Saudi National Bank—said it would not come to the rescue with new funding. On Friday, the Financial Times reported that fellow Swiss bank UBS might be a reluctant suitor (earlier in the week, the $57 billion behemoth said it had little interest in buying the troubled bank). As we write this, UBS has offered $1 billion to take over Credit Suisse, which had a market cap of $35 billion just two years ago and $8 billion at the beginning of the month. Meanwhile, Switzerland is considering nationalizing the firm if the UBS deal fails. Stunning.
Considering everything that happened over the course of five days, it is rather impressive that the benchmarks were relatively unchanged. The NASDAQ, in fact, gained 4.4% on the week. One thing is certain: tech startups which had little trouble securing loans in the zero interest rate environment are going to face much higher hurdles—and debt servicing costs—going forward. Which makes it somewhat strange that the tech-laden benchmark put together a positive week.
The same issues that drove markets this past week will drive them this week: global concerns about the financial strength of middle market and regional banks, and how the Fed will balance battling inflation with these new banking concerns. Expect the Fed's balance sheet reduction program to be placed on pause just as it was beginning to show results.
Mo, 13 Mar 2023
Financial Services
One week, three bank failures; shades of 2008?
We all recall the nightmarish string of bank failures back in 2008 stemming from toxic mortgage-backed securities poisoning the capital of these doomed giants. While we are certainly not at that level of concern right now, the failure of three banks over the course of a few days has the markets on edge.
First came Silvergate Capital (SI $2), the premier lender to the cryptocurrency industry. The California state-chartered bank, which provided financial services such as commercial banking, business lending, and cash management to its customers, sent up red flags when it announced it was closing its Silvergate Exchange Network which served as a bridge between traditional banking services and the crypto world. Then the company said it would not be able to file its required 10-K to the SEC on time. That was all it took for a run on the bank: customers began pulling out some $8 billion worth of deposits, forcing Silvergate to secure a loan from the Home Bank Loan system. Furthermore, the bank was forced to sell the solid assets on its balance sheet such as Treasuries and securitized residential mortgage loans at discount prices to fund the customer withdrawals. These assets were discounted because of the Fed rate hikes—the bank simply didn’t have the luxury of waiting for the securities to mature at par. By late in the week, Silvergate announced it was winding down its operations. Sadly, the story did not end there.
Silicon Valley Bank, the major arm of SVB Financial Group (SVB, trading halted), collapsed on Friday, becoming the second-largest bank failure in US history (Washington Mutual, which failed during the financial crisis, was the largest). The FDIC quickly moved in to take control, creating a new entity called the Deposit Insurance National Bank of Santa Clara. SVB was the 16th largest bank in the country, with around $210 billion in assets, and was the go-to bank for tech startup firms—many of whom wouldn’t have been able to access funding otherwise.
As for cryptocurrency shops, the preferred lender behind Silvergate has been New York-based Signature bank (SBNY, trading halted). On Sunday, regulators closed the doors of this institution, which held nearly $100 billion on deposit. New York Governor Kathy Hochul said this did not amount to a taxpayer bailout, as the funds required to pay back depositors would come from "the fees assessed on all banks." She was referring to the Deposit Insurance Fund, which will guarantee money above and beyond the FDIC limit—or "uninsured" funds.
These closures lead many to wonder why companies would not have better risk management with respect to their deposits, spreading around their money to a number of different financial institutions. For example, streaming device company Roku said it had some $500 million—or 26% of its cash reserves—in an account at SVB. A who’s who list of prominent companies have already announced they are in a similar situation. Per one seasoned venture capitalist, if a tech startup received loans from a bank, that institution pretty much demanded that the bulk of their cash be kept at the firm. Furthermore, tech companies overwhelmingly trusted SVB, Silvergate, and Signature. They simply couldn't believe there would ever be a run on these banks.
In the wake of these meltdowns and with rates much higher rates than a year ago, these tech startups must now be wondering where they can possibly turn for new sources of funding. The troubles in Silicon Valley won't go away with the government's promised backstop.
Two thoughts come to mind. As the interest rate hike cycle began, we were told how this would help the major financial institutions, as their net interest income—the difference between what they could make on loans and what they had to pay on investors’ deposits—would increase greatly. We didn’t buy that argument this time around, and Financial Services remains our most underweighted sector. Second thought: Many experts have been saying for the past several months that the Fed would continue to raise rates until they “broke things.” Mission accomplished. If the hot jobs numbers and the recent inflation reports were pointing to a 50 bps hike at the March meeting, the broken pieces laying on the floor around them should give the Fed pause. We still believe a 25-bps hike will be announced on the 20th, but odds for an immediate pause are growing. And 50 bps is now all but off the table.
Th, 09 Mar 2023
Technology Hardware & Equipment
Exit, stage left: Apple is expediting its move out of China and into India
India just surpassed China as the world’s most populous nation, with 1.412 million citizens, but size is just a minor factor in Apple’s (AAPL $152) hurried exodus out of the communist nation and into the South Asian country. The world’s largest publicly traded company ($2.4 trillion as of this writing) had a rare contraction in sales of 5.5% in the last quarter of 2022 as compared to the prior year, but it posted record revenues in India. Couple that with China’s growing ties to Russia, a continuing Covid nightmare in the country, and saber-rattling against the West (especially the US), and it makes sense that Apple would be packing up, so to speak, and heading west. And where Apple goes, its suppliers are sure to follow.
Key suppliers to the Cupertino-based firm are increasingly being asked one question by their corporate customers: “When can you move out (of China)?” An executive at GoerTek, an AirPods manufacturer, said that 90% of his American tech firm clients are asking that question on a near-constant basis, and the pressure is growing. While Vietnam has been a major destination for many of these firms, India has been building momentum. For the first time ever, Apple has designated India as its own region, as opposed to simply being part of a larger geographic area including Middle Eastern, Eastern European, and African nations. Somewhat surprisingly, Apple still doesn’t have a physical footprint in India via retail outlets, but that will change beginning later this year. Apple recently created an online store dedicated to serving its Indian customers.
In addition to reading the writing on the wall with respect to increasingly strained US-China relations, Apple has faced tumult at its Chinese facilities recently. Late last year, at its massive Foxconn plant in Zhengzhou, violent protests broke out as workers rioted against low pay and Covid restrictions. Up to 85% of iPhone Pros had been produced at that facility. It appears as though Apple is finally getting the message.
Why did it take so long for American companies to wake up to the risks of concentrating operations in a state-controlled country? Quite simply, they were chasing profits and ignoring the obvious threats. A little over a generation ago, Americans could flip over common retail goods and read the “Made in Japan” label. Overwhelmingly, those labels now read “Made in China.” It will take some time to change that, but the exodus has begun—and we don’t see anything on the horizon that will derail the movement.
Tu, 07 Mar 2023
Housing
The Fed is raising rates to cool inflation, but one segment will remain immune
The long-term average 30-year mortgage rate is 7.75%; as of this writing—despite what the accompanying chart shows—we have retaken the 7% level. While 7.75% is the long-term average, the ten-year average mortgage rate sits at 4%; but, for a brief two-year period, we sat in a trench below that level. The typical American may make some poor financial decisions, but a large percentage of the US population did something brilliant over that spell: they either financed a new purchase at rock-bottom rates or they refinanced their existing home with a fixed-rate loan. While 10% of current home loans are the adjustable-rate (ARM) variety, that is well below the historic average (40% of mortgage loans were ARMs back in 2006, for example). For Americans locking in 2.65% to 4% rates, it is time to celebrate. For the Fed, not so much.
The Fed has a dual mandate: keep the unemployment rate reasonably low and keep inflation somewhere around the 2% rate. While the first mandate has obviously been met, the central bank continues to raise rates in an effort to bring down the stubbornly high level of inflation. Were they operating in most other countries (a 30-year fixed-rate home loan is a uniquely American experience), they would be having an easier time. However, the 40% of homeowners who took out those low-rate loans in either 2020 or 2021 are immune from the Fed’s actions—at least with respect to their largest expense. They may be locked into their existing home, but that extra purchasing power will remain intact for decades. Sadly, evidence is mounting that many Americans are once again spending beyond their means: credit card balances just hit a new record high. And for anyone who has looked at their credit card interest rates lately, it is clear that the banks wasted no time in spiking those very-adjustable rates.
With such a large percentage of homeowners locked into their current homes due to low mortgage rates, the housing industry will continue to be negatively impacted. In a warped sense, this is what the Fed wants to see—lower or stagnate home prices due to reduced demand, and higher unemployment in the industry due to a pullback in construction. Investors should keep in mind that the homebuilders reside in the Consumer Discretionary sector; a segment which is already facing headwinds due to the probable recession on the horizon. We have been underweighting this sector since the middle of last year.
Headlines for the Month of February, 2023
Mo, 27 Feb 2023
East/Southeast Asia
Xi tells China’s military establishment to be prepared for Taiwan invasion by 2027
According to CIA Director William Burns, Chinese President Xi Jinping has conveyed a strategic message to the People’s Liberation Army: Be prepared to invade and take control of Taiwan by 2027. To be clear, there is no possible scenario in Xi’s mind in which Taiwan is not fully under the thumb of Beijing. If anyone still believes that they don’t understand the mind of a communist like Xi and the history of Taiwan going back to 1949. Jimmy Carter certainly didn’t understand the mind of a Chinese communist, or he wouldn’t have cut ties with a democratic Taiwan in favor of improved relations with Beijing. But the myopia certainly hasn’t been limited to one party: both sides have been in power as the US became overly reliant on cheap goods and an enormous potential market in the East. Never mind that the Western values of individual liberty and personal freedom are anathema to communism. We wonder if anyone ever believed that the balance of trade between the US and China would be anything other than grossly lopsided?
Now, despite that country’s unwillingness to take any responsibility for the pandemic unleashed on the world, many want us to believe that Xi is sitting back, watching his buddy Putin sink in the quicksand that is Ukraine, and second-guessing his plans to invade Taiwan. He is probably furious at his friend for shining the spotlight on the similarities between Ukraine and Taiwan with respect to their bully neighbors, but he would be sending arms to Russia for use in the conflict right now if the world weren’t watching his actions so closely. Just before the start of the Olympics, Putin promised Xi two things: that he would wait to invade until after the games had concluded, and that war would be swift and victory assured. Xi must be taken aback by both the toughness of the Ukrainian people and the cohesion of the Western world against this horrific act.
The West must now make it clear that we are willing to defend Taiwan (and the president has said as much), and that a swift victory would not be possible. His mind may still be made up, but doubt has crept in—at least about going in before 2027.
Americans should pay attention to where the goods they buy are sourced and also have a basic understanding of the modern geopolitical world. For example, Vietnam has been a major recipient of US manufacturing deals as companies scramble to exit China; Vietnam has strained relations with China and continues to be a growing economic partner to the US. The same could be said of Malaysia, Bangladesh, Taiwan, and India—though the latter has ruffled feathers with its continued purchase of Russian energy. The United States played a major role in China’s economic growth over the past generation. Now, with a full understanding of that nation’s strategic plans, we have the power to impede that growth trajectory. But do we have the stomach for it?
Th, 23 Feb 2023
Metals & Mining
Two catalysts for lithium miners' recent volatility: Tesla and a Chinese battery company
In the mad dash to create more efficient batteries for electric vehicles, few elements, literally, are more important than high-grade lithium. Mining projects to produce this valuable element, however, are costly and can take years to get up and running. These factors should make current lithium miners extremely valuable; and, in fact, a look at the three year returns for the major players shows them far outpacing the performance of their respective benchmark indexes. But last Friday something odd happened: lithium miners got crushed, falling around 10% on average and leaving investors befuddled as to why.
It turns out that two companies on different sides of the planet led to the drop. In China, the world’s largest EV battery maker, Contemporary Amperex Technology (aka CATL), pulled a fast one. Without warning, the company changed its pricing structure on batteries to a lithium-based model, which had the effect of greatly reducing the price it charges per unit. Since CATL produces its own lithium from company-owned mines, it has the ability to reduce profit margins on the input side to virtually nothing—a luxury most EV battery makers don’t have.
With CATL’s actions in mind, it recently came to light that major US electric battery producer Tesla (TSLA $202) may be interested in acquiring mid-cap ($3.6B) miner Sigma Lithium Corp (SGML $35). This Vancouver-based company mines high-purity lithium from its enormous mining operation in Brazil. While the other miners were watching their shares plunge, SGML shares were busy spiking nearly 20%.
While Tesla said that Sigma is but one of many options being considered, it clearly wants to control its own mining operation. For a company with a clear history of vertical integration, the move makes perfect sense. Close to the port city of Corpus Christi, Tesla is in the process of building its own lithium processing plant, scheduled to be up and running by next year. Investors are betting that a company-owned mining firm won’t be far behind. If it doesn’t turn out to be Sigma, however, look for those shares to plunge back to earth.
Yes, Tesla shares have doubled in price since January 6th, but we still consider them a bargain. As for the miners, we prefer industry leader Albermarle (ALB $252, $35B market cap) and small-cap miner Lithium Americas Corp (LAC $23, $3.5B market cap). The latter is developing three new lithium production facilities—two in Argentina and one in Nevada—with the ultimate goal of splitting into two companies based on geography. The need to diversify away the risk of relying on China for critical elements and rare earth minerals has never been more evident, which should provide ample opportunity in the space for astute investors looking closer to home.
Th, 16 Feb 2023
Hotels, Resorts, & Cruise Lines
Airbnb stock soars after its first fully profitable year
On 07 December 2022, just over two months ago, Morgan Stanley downgraded travel services company Airbnb (ABNB $143) and slashed its price target to $80 per share. The shares immediately fell 5% on the news, and we immediately added the company to the Penn Global Leaders Club. We didn’t buy into the analyst’s narrative, but we did buy into CEO Brian Chesky’s intelligent strategic vision for the company. Our initial price target for ABNB shares was $145. Ten weeks later, the shares have moved 56% above our purchase price, and we still consider them a bargain.
The latest catalyst for the move higher was a stellar Q4 earnings report. Revenues rose 24%—to $1.9 billion—from the same period a year earlier, and profits came in nearly double what was expected ($0.48 vs $0.25). Most importantly, after losing $4.6 billion in 2020 (pandemic) and $300 million in 2021, the company just posted its first profitable year, bringing in $2 billion on $8.4 billion in revenue. That equates to an impressive 22.52% operating margin. While others (like Vrbo) enter the business and while the hotels try new tactics to emulate what Airbnb has created, Chesky’s company remains on the cutting edge of new technologies designed to increase its dominance in the space. Meanwhile, Airbnb sits on a $10 billion mountain of cash, a tiny relative debt load of $2 billion, and a demand backlog due to a record number of new bookings. Suddenly, the analysts are changing their tune.
Even though the shares have run up to near our price target in a matter of months, our Global Leaders Club purchases are designed to be longer-term holdings. In other words, we won’t be selling at $145. Airbnb is the only travel-related company we currently own in the Club—the hotels remain a bit too expensive, and the cruise lines (we prefer Royal Caribbean and Norwegian) could be further affected by softening economic conditions.
Tu, 14 Feb 2023
IT Software & Services
Palantir soars after the company announces its first profitable quarter
Shares of data software company and Penn New Frontier Fund member Palantir (PLTR $9) soared double digits after the company reported its first quarterly profit, earning $31 million in Q4. Revenues rose 18% from a year ago, to $509 million, with government revenue jumping 23% and commercial sales growing by 11%. CFO David Glazer said he expects that rate of growth to continue throughout 2023.
Denver-based Palantir aggregates massive amounts of data to produce usable, actionable information for its government and civilian clients. As our favorite example, the company was essential in collecting and analyzing the data which ultimately allowed US forces to track down and kill terrorist Osama bin Laden. Palantir’s customer mix is roughly 60% government and 40% civilian sector, respectively, with 43% of its revenues emanating from outside of the US. As a policy, the company will only deal with nation-states aligned with the values of the United States—no bad actors welcome. With cash on hand of $2.5 billion, Palantir holds no debt on its books.
The company’s three platforms, Palantir Gotham, Palantir Foundry, and Palantir Apollo, are unrivaled in the industry, and we fully expect the firm to maintain its benchmark position. We opened our position in the Penn New Frontier Fund within minutes of its IPO, purchasing shares roughly where they now sit. We maintain our $20 price target on the shares and would not be a seller once that level is reached.
Th, 09 Feb 2023
Media & Entertainment
Bob Iger’s return is already paying dividends for Disney
There was at least one person enamored with former Disney (DIS $116) Ceo Bob Chapek: Bob Chapek. Everyone else, not so much. After nearly three years of floundering under the woeful boss, Bob Iger is back; and, based on the first few months of his well-publicized return, the stock might be as well.
After plunging 44% in 2022, shares of Disney have already rebounded 35% in the first six weeks of 2023, buoyed by a strong earnings report and a $5.5 billion cost-cutting program laid out by Iger. First the numbers: Revenues rose 7.7% from Q1 of 2022, to $23.51 billion, while diluted earnings per share came in at $0.99, beating forecasts of $0.77. Disney+ subs disappointed, with the company losing some 2.4 million subscribers over the course of the quarter, though ESPN+ and Hulu—two Disney units—both gained subscribers. Parks revenue continues to impress, jumping 21% from last year—to $8.74 billion—and beating estimates.
What investors really applauded was Iger’s announced $5.5 billion cost savings plan, with $3 billion of that coming from content cuts. Iger also disclosed a headcount reduction of 7,000, or around 3% of the workforce. All of this apparently appeased activist investor Nelson Peltz of Trian Partners, who declared his proxy fight with the company officially over. Iger understands business and how to deal with activist investors; Chapek would have surely invited—and ultimately lost—this battle. Disney still has a lot of work to do (it has already lost the battle with the state of Florida over ownership of the land on which Walt Disney World sits), but we expect more intelligent leadership out of Iger.
We added Disney back into the Penn Global Leaders Club the same morning Chapek was fired (actually, he was fired over the weekend—to his shock—and we picked up shares at Monday’s open), and the shares are up substantially since that point. Recession or not, we anticipate the parks revenue to continue its post-Covid growth trajectory despite the recent price hikes. Our initial target price for the shares is $150.
Sa, 04 Feb 2023
Week in Review
Bookend bad days didn’t stop the market from plowing ahead this week
The week started off rough, with investors worrying about (potentially) bad earnings reports to come and a Fed which wasn’t prepared to stop raising rates. The latest hike did, indeed, come on Wednesday when Powell and the FOMC announced another 25-basis-point increase, bringing the upper band of target federal funds rate to 4.75%. There seemed to be something different about his press conference this time around, however. His typically hawkish tone seemed a bit mellower, which investors took as a good sign. After being down before and during the rate hike announcement, the market reversed course and finished higher.
Friday brought the real shocker. We are back in bizarro world where good economic news is bad for the markets, and did we ever get some good economic news via the jobs report. Economists were expecting to hear that 187,000 or so jobs had been created in January; the actual number came in at a scorching 517,000 new nonfarm payrolls. The unemployment rate, which many argue needs to be higher for the Fed to pause, dropped to its lowest level since 1969—3.4%. Leisure and hospitality posted huge jobs gains, as did professional and business services, government, and health care. Putting the aggregate number in perspective, it was almost twice as high as December’s strong gain of 260,000 new jobs.
Since the worrisome factor of a strong jobs report is the potential for a wage-price spiral (more people working means more money to spend which means higher prices), all eyes turned to wage growth in the report. For the month of January, wages increased at a 4.4% year-over-year clip. That may seem high, but the number has been steadily coming down since March of last year, and it is inching ever closer to the 2.96% long-term average. As the numbers were digested, they became more palatable. What could have been a lousy finish to the week turned into manageable losses. The only benchmark dropping for the week was the Dow, which only shed fifteen points over the five sessions. Small caps, as measured by the Russell 2000, gained nearly 4% on the week.
There is an old market expression: “As goes January, so goes the year.” We believe that will hold true this year, which would help erase a lot of 2022’s pain. The S&P 500 finished January up 6%, the Russell 2000 was up 10%, and the NASDAQ was up nearly 11%. Bonds, which were down double digits in aggregate last year, are up 3% thus far as represented by the Bloomberg US Aggregate Bond index. So far, so good.
Th, 02 Feb 2023
Energy Commodities
Remember when natural gas was going to be the investment of the decade?
Think back for a minute to last summer. There were a lot of nightmare scenarios dancing around the economic horizon, but few more haunting than Vlad Putin’s desire to make Europeans pay for their support of Ukraine in the war. His number one weapon was energy, and endless stories painted a dire picture of gas bills quadrupling on the continent and many being left without natural gas to heat their homes. For investors, this pointed to an incredible opportunity to invest in the energy commodity using instruments such as UNG ($8.50), the United States Natural Gas ETF.
Indeed, shares of UNG had risen from around $12 going into 2022 to $34.50 by August, a gain of some 187%. And that was during the warm days of summer; imagine (argued investors) how high they might go during the frigid European winter! Fast forward six months. UNG is sitting at $8.50, or 75% lower than it was in August. What happened? A prolonged spell of mild weather on the continent and stronger-than-expected supply inventories have combined to knock natural gas prices back down to pre-war levels. US natural gas production is hitting record highs (we are the world’s largest producer), and US LNG exporters increased shipments to Europe by nearly 150% year-over-year. Europe’s dependence on Russian gas has dropped from over 40% to near zero, yet Putin’s dream of exacting pain has failed to manifest. The pain to be felt in Russia by lost revenue due to his actions, however, is just beginning.
We distinctly remember the copious stories in the financial press about natural gas facilities being knocked offline by storms in the US, the hardship Europeans would face over the winter months, and the critical shortage of LNG. What seemed like a no-brainer of an investment turned into a nightmare for anyone buying into the hype. Yet another great lesson on behavioral finance and the false narratives so prevalent within the media. Always do your homework before investing, and have a specific exit strategy if events don’t play out as expected.
Headlines for the Month of January, 2023
Tu, 31 Jan 2023
Automotive
After its best week in a decade, Tesla is delivering a message to perma-bears
Let’s face it, a rather large number of analysts have been hoping for Tesla’s (TSLA $172) demise just to vindicate their perma-bear positions on the EV maker. Last year provided them a great opportunity to crow, with Tesla shares falling some 65% in 2022. Going into 2023, they were all but writing the company’s epitaph, reminding us of falling production in China and the CEO’s preoccupation with another entity. There’s only one problem with that narrative: Tesla just posted a record quarterly profit.
Revenue jumped 37%, from $17.7B to $24.32B, with $3.69B flowing down as net income—a 40% spike from the same quarter last year. Both top-line revenue and bottom-line profits hit new records. Guidance was also strong, with management reiterating its goal of 50% CAGR in deliveries. For 2023, the company plans to produce—and sell—some 1.8 million vehicles, with a “potential” to hit the two million mark. The results were simply better than expected, but don’t expect the bears to change their tune.
Tesla is currently producing around 3,000 Model Y SUVs at its Austin plant alone, and is preparing that plant to begin producing the highly anticipated Cybertruck. The futuristic-looking all-electric pickup will begin rolling off the assembly line this month, with production ramping up to scale in 2024. While naysayers point to the company’s recent price reductions as evidence of waning demand, we would argue that the price cuts are possible because no other car company can produce electric vehicles at a lower cost, thanks to Tesla’s massive head start and unmatched production efficiencies. If other automakers try to reduce prices to keep pace, they will push their EV margins even further into the red. And that is exactly what we expect them to do—despite their insistence that Tesla has zero influence on their tactics or strategy.
Tesla is expected to generate over $12 billion in free cash flow this year, with the next closest car company (Toyota) coming in around $10 billion. With the Cybertruck coming online, as well as a lower-cost vehicle to widen its customer base, Tesla remains in the most enviable position of any car company. And that is not even accounting for the company’s renewable power and battery storage lines—also on the leading edge of their respective businesses. We maintain our $333 price target on TSLA shares, which we own in the Penn New Frontier Fund.
Mo, 30 Jan 2023
Restaurants
What layoffs? Chipotle hiring 15,000 new workers for “burrito season”
Every day brings new stories of layoffs, the rising cost of food items, and an impending recession. If one industry should be reeling from these conditions, it is the fast-food category, right? Fast-casual chain Chipotle Mexican Grill (CMG $1,614) begs to differ. Not only is the Penn Global Leaders Club member hiring 15,000 new workers ahead of spring “burrito season,” it is also in the early stages of a new expansion plan which would double its North American and European footprint—from around 3,000 restaurants to 7,000.
With nearly 100,000 employees currently, the new hires would represent a 15% increase in Chipotle’s workforce. How deeply is the company going into debt to fund its hiring and expansion plans? The $45 billion Mexican restaurant carries zero debt on its books and has a war chest of nearly $1 billion in cash and short-term equivalents. The restaurant business is notoriously tough, with enormous overhead, slim margins, and a fickle customer base; others in the industry should take note of what CEO Brian Niccol has been able to accomplish.
We added Chipotle to the Penn Global Leaders Club in March of 2020 at $590.85 per share. We would place a fair value on the company’s shares at around $1,700.
We, 25 Jan 2023
IT Software & Services
Microsoft had a strong quarter; it was the guidance which spooked investors
For the fiscal second quarter—ended 31 December—Microsoft (MSFT $242) posted revenues of $52.7 billion—a record high. Earnings (diluted) came in at $2.20 per share, or several cents above expectations. With everyone bracing for a disastrous earnings season with respect to tech stocks, investors breathed a sigh of relief, driving MSFT shares up 5% in after-hours trading. A rather sobering conference call and muted guidance quickly took those gains back, but we continue to see the software giant as an undervalued gem sitting at an attractive price.
Satya Nadella, who took charge of the company nearly a decade ago (hard to believe), immediately began reshaping Microsoft as a dominant cloud player, with Azure serving as the cornerstone. To say that strategy is paying off would be an understatement. Many other CEOs would have continued to rely on legacy moneymakers; in the case of Microsoft, that would have meant its More Personal Computing segment.
Overall, that segment was down 19% for the quarter (yes, currency headwinds did account for a few percentage points); Xbox revenues fell 12%, while device revenues (think Surface) fell a stunning 39%. It is a good thing Nadella came along a decade ago and began reshaping the company’s strategic vision. The Intelligence Cloud unit, which houses Azure, was up 18% in fiscal Q2, and would have been up 24% in constant currency (CC). The Productivity and Business Processes segment, which includes the massively successful Office 365 division as well as the LinkedIn unit, rose 7%. Finally, search and news ad revenue—minus traffic acquisition costs—was up 10%. Other than the weaker-than-expected March guidance and the fact that Microsoft will be laying off some 5% of its workforce (10,000 workers), it really wasn’t a bad quarter at all. Unless you happen to be one of those unfortunate workers, of course.
Microsoft remains a core holding within the Penn Global Leaders Club and is now up some 476% since we added it. Satya Nadella was the main catalyst for its addition to the Club. We would place a fair value on the shares at $320.
Th, 12 Jan 2023
Supply, Demand, & Prices
Enough data points are in: the Fed can (and will) take their foot of the gas
The never-ending blather in the press about the Fed’s tightening cycle has been painful to watch and listen to. We would argue that roughly half of the concerns expressed have been made up by the press itself. Had they simply chosen to adopt the real story (“Rates are at zero; the Fed must raise them to a responsible level to control inflation”) instead of crafting faulty narratives, we don’t believe the markets would have seen the same level of destruction in 2022. So, without regard to what the narrative du jour may be, let’s look at the facts with respect to inflation and rates.
Yet another strong data point came in with Thursday’s CPI report. The cost of living dropped 0.8%—a contraction not seen since April of 2020 during the early days of the pandemic—and the annual rate of inflation fell for a sixth-straight month—to 6.45% from a high of 9.1% last summer. If everyone knows that Fed adjustments have a lag, why has the press been freaking out investors since the hikes began? This downward pressure on inflation is precisely what we expected to see take place, and it is evidence that the hikes are having their desired effect. The unemployment rate may not be going up, but (wonderfully) that is not needed, as wages are finally cooling.
The price of groceries barely budged in December, and gas prices fell over 9%. The cost of shelter remains a major sticking point, as rents jumped 0.8% in the month and mortgage rates remain substantially higher than they were a year ago. Still, several Fed governors gave a nod to the positive report and indicated a slowing of hikes is probably warranted. That was enough to help the markets cobble together a steadily positive day.
Here is what we see happening: The Fed will hike rates just 25 basis points on the 1st of February, another 25 bps in the middle of March, and then halt—putting the upper band of the federal funds rate at 5%. Despite what investors may think, there will be no tightening due to any recession in 2023. Rather, the Fed will sit on that 5% rate for some time. That is not only what we expect, it is also what we want. It is time to start reining in wanton behavior and reduce the Fed’s balance sheet. Maybe we can even hold the $32 trillion national debt steady for a while (insert laugh track here).
Tu, 10 Jan 2023
Government Watchdog
The government is coming for your gas stove
Before you label this story hyperbole, consider this: the city of Los Angeles has already banned gas appliances from being placed in new homes, and the state of California is trying to pass the same law. Let’s consider what is going on at the federal level. You may be familiar with the name Richard Trumka. Before his death last year, Trumka was an organized labor leader and head of the AFL-CIO. In 2021, President Joe Biden appointed his son, Richard Trumka Jr., to head up the US Consumer Product Safety Commission. As with the partisan hack Lina Khan at the FTC, Trumka has turned the CPSC into a political tool, which leads us to the gas stove ban.
Under the ruse that gas stoves are a major source of indoor pollution and a health risk, Trumka told Bloomberg that “products that can’t be made safe can be banned.” Adding fuel to the fire, so to speak, senators Corey Booker and Elizabeth Warrant back the ban, arguing that Black, Latino, and low-income households bear the brunt of this national health crisis, as they do not have the means to properly ventilate their homes. Never mind the economic impact on these lower-income households, considering how much cheaper it is operate gas stoves as opposed to their electric counterparts.
This type of government overreach is both despicable and predictable. When government agencies are not held accountable by the people they supposedly represent, they are able to get away with outrageous acts. Hopefully, there will be a large enough outcry to stop this ban from taking place, but it clearly shows the arrogance of the elite ruling class. We would expect nothing less from a Trumka.
Oddly (not), the press has been quite mum on this topic. Since these individuals purport to be the spokespeople of the disenfranchised, why don’t we take a poll among ordinary Americans in the inner cities and ask them—without mentioning who proposed the ban—whether or not they support this decree? We are fairly sure how they would respond. (Around 35% of American households cook with gas stoves.)
Mo, 09 Jan 2023
Global Strategy: The Americas
Thawing of relations: Chevron shipping 500,000 barrels of oil from Venezuela
Any hopes of helping depose Hugo Chavez’ hand-picked successor in Venezuela, Nicolas Maduro, appear dashed; time to start exporting Venezuelan crude. The Biden administration granted an expanded license to oil giant Chevron (CVX $177) for the purpose of opening back up the supply of oil from Venezuela to the US and other western nations. The first tanker, in fact, has already picked up its load. After four years of sanctions which have done little to change the political dynamic in the country, the administration is trying another tack.
The amount of money Chevron might make out of the deal will be constricted due to the terms of the license; but, considering the billions of dollars owed by the PDVSA—Venezuela’s state-owned oil agency—to the company, it has little to lose. From the US government’s standpoint, the idea is to slowly increase ties with the nation in return for political reform and “free and fair” elections to be held later this year. As for the heavy crude, it is headed to refineries on the US Gulf Coast. The European Union has also been granted an exception for receiving Venezuelan oil to help offset the losses from the Russian embargo. The South American nation has the world’s largest proven oil reserves—some 35 billion more barrels, in fact, than Saudi Arabia.
The way the people of Venezuela are suffering, this is the best possible course of action for the US to take. Eventually, the citizenry will force change; the more draconian our approach to the country, the easier it will be for the Maduro administration to make the US a scapegoat for the economic turmoil.
Mo, 09 Jan 2023
Application & Systems Software
Lessons from Salesforce: If your company gets acquired, your job is not safe
In 2018, relationship management software company Salesforce (CRM $140) bought data integration firm MuleSoft for $6.5 billion. The following year it purchased data visualization company Tableau for $15.3 billion. Two years later, it purchased the business messaging platform Slack for a whopping $27.7 billion. Salesforce CEO Marc Benioff has an appetite as large as his ego, which should have served as a warning to the employees he gobbled up in the deals.
Salesforce has been crushed by the tech reckoning, with its shares trading down 55% from their bloated highs. Benioff, who made $28.6 million last year, is now taking it out on his staff by laying off 10% of the workforce—gutting the companies he accumulated on his wanton buying spree. In a memo to employees, Benioff said the company simply hired too many workers during the pandemic. That is no doubt true, but the ill-conceived acquisitions lie directly at the feet of Benioff, not an economic slowdown. As for those let go due to the CEO’s miscalculations, most were notified via blast emails stating that their positions had been eliminated. That is rich considering the company’s stated corporate culture revolves around the “concept of Ohana,” a Hawaiian term for taking care of one another through a family bond.
We have seen CEOs like Benioff many times over the past generation: blowhards who are never wrong and who run their company like a personal plaything. Workers at such firms must always be ready to face personal and professional upheaval.
Th, 05 Jan 2023
Specialty Retail
Bed Bath & Beyond expresses “substantial doubt” about future, shares plunge
Nine years ago, Bed Bath & Beyond (BBBY $2) was a $17 billion company with shares trading in the $80 range. Five short months ago, shares had rallied back into the $23 range as investors grew more optimistic that the company could pull out of its funk. Those hopes were dashed this week after the company said it was unable to file its Q3 report on time, expressing “substantial doubt about the company’s ability to continue.” That vote of no confidence from management sent shares tumbling 23% at the open, hitting an all-time low of $1.82.
What’s next for the specialty retailer, which now has a market cap of under $150 million? Bankruptcy protection, more than likely, will be the ultimate answer. The company could also attempt to restructure its debt, which might be difficult considering its 300% debt/equity ratio (it has some $1.7 billion in liabilities). Unaudited Q3 results point to sales of around $1.3 billion, down 33% from the same quarter last year, which the company attributes to slower traffic and reduced inventory levels. The latter is a real issue, as suppliers are reluctant to provide hard goods to a company which may not be able to pay them. Analysts had been expecting a net loss in the third quarter of $158 million; we can expect real losses to come in at more than double that figure. The more we look at the financials, the harder it becomes to see any exit strategy outside of bankruptcy protection.
It would be nice to see Bed Bath & Beyond purchased by a private equity firm and taken private, with a continued bricks-and-mortar footprint, but that may be wishful thinking. There is another aspect to this story for investors to be aware of: A dozen REITs report the company as a tenant, with Kimco Realty (KIM $21) holding a plurality of the leases. We have been warning investors about the challenges facing office and retail REITs going forward, and we believe the market is still underestimating the risk. Now is the time to review your real estate holdings.
Tu, 31 Jan 2023
Automotive
After its best week in a decade, Tesla is delivering a message to perma-bears
Let’s face it, a rather large number of analysts have been hoping for Tesla’s (TSLA $172) demise just to vindicate their perma-bear positions on the EV maker. Last year provided them a great opportunity to crow, with Tesla shares falling some 65% in 2022. Going into 2023, they were all but writing the company’s epitaph, reminding us of falling production in China and the CEO’s preoccupation with another entity. There’s only one problem with that narrative: Tesla just posted a record quarterly profit.
Revenue jumped 37%, from $17.7B to $24.32B, with $3.69B flowing down as net income—a 40% spike from the same quarter last year. Both top-line revenue and bottom-line profits hit new records. Guidance was also strong, with management reiterating its goal of 50% CAGR in deliveries. For 2023, the company plans to produce—and sell—some 1.8 million vehicles, with a “potential” to hit the two million mark. The results were simply better than expected, but don’t expect the bears to change their tune.
Tesla is currently producing around 3,000 Model Y SUVs at its Austin plant alone, and is preparing that plant to begin producing the highly anticipated Cybertruck. The futuristic-looking all-electric pickup will begin rolling off the assembly line this month, with production ramping up to scale in 2024. While naysayers point to the company’s recent price reductions as evidence of waning demand, we would argue that the price cuts are possible because no other car company can produce electric vehicles at a lower cost, thanks to Tesla’s massive head start and unmatched production efficiencies. If other automakers try to reduce prices to keep pace, they will push their EV margins even further into the red. And that is exactly what we expect them to do—despite their insistence that Tesla has zero influence on their tactics or strategy.
Tesla is expected to generate over $12 billion in free cash flow this year, with the next closest car company (Toyota) coming in around $10 billion. With the Cybertruck coming online, as well as a lower-cost vehicle to widen its customer base, Tesla remains in the most enviable position of any car company. And that is not even accounting for the company’s renewable power and battery storage lines—also on the leading edge of their respective businesses. We maintain our $333 price target on TSLA shares, which we own in the Penn New Frontier Fund.
Mo, 30 Jan 2023
Restaurants
What layoffs? Chipotle hiring 15,000 new workers for “burrito season”
Every day brings new stories of layoffs, the rising cost of food items, and an impending recession. If one industry should be reeling from these conditions, it is the fast-food category, right? Fast-casual chain Chipotle Mexican Grill (CMG $1,614) begs to differ. Not only is the Penn Global Leaders Club member hiring 15,000 new workers ahead of spring “burrito season,” it is also in the early stages of a new expansion plan which would double its North American and European footprint—from around 3,000 restaurants to 7,000.
With nearly 100,000 employees currently, the new hires would represent a 15% increase in Chipotle’s workforce. How deeply is the company going into debt to fund its hiring and expansion plans? The $45 billion Mexican restaurant carries zero debt on its books and has a war chest of nearly $1 billion in cash and short-term equivalents. The restaurant business is notoriously tough, with enormous overhead, slim margins, and a fickle customer base; others in the industry should take note of what CEO Brian Niccol has been able to accomplish.
We added Chipotle to the Penn Global Leaders Club in March of 2020 at $590.85 per share. We would place a fair value on the company’s shares at around $1,700.
We, 25 Jan 2023
IT Software & Services
Microsoft had a strong quarter; it was the guidance which spooked investors
For the fiscal second quarter—ended 31 December—Microsoft (MSFT $242) posted revenues of $52.7 billion—a record high. Earnings (diluted) came in at $2.20 per share, or several cents above expectations. With everyone bracing for a disastrous earnings season with respect to tech stocks, investors breathed a sigh of relief, driving MSFT shares up 5% in after-hours trading. A rather sobering conference call and muted guidance quickly took those gains back, but we continue to see the software giant as an undervalued gem sitting at an attractive price.
Satya Nadella, who took charge of the company nearly a decade ago (hard to believe), immediately began reshaping Microsoft as a dominant cloud player, with Azure serving as the cornerstone. To say that strategy is paying off would be an understatement. Many other CEOs would have continued to rely on legacy moneymakers; in the case of Microsoft, that would have meant its More Personal Computing segment.
Overall, that segment was down 19% for the quarter (yes, currency headwinds did account for a few percentage points); Xbox revenues fell 12%, while device revenues (think Surface) fell a stunning 39%. It is a good thing Nadella came along a decade ago and began reshaping the company’s strategic vision. The Intelligence Cloud unit, which houses Azure, was up 18% in fiscal Q2, and would have been up 24% in constant currency (CC). The Productivity and Business Processes segment, which includes the massively successful Office 365 division as well as the LinkedIn unit, rose 7%. Finally, search and news ad revenue—minus traffic acquisition costs—was up 10%. Other than the weaker-than-expected March guidance and the fact that Microsoft will be laying off some 5% of its workforce (10,000 workers), it really wasn’t a bad quarter at all. Unless you happen to be one of those unfortunate workers, of course.
Microsoft remains a core holding within the Penn Global Leaders Club and is now up some 476% since we added it. Satya Nadella was the main catalyst for its addition to the Club. We would place a fair value on the shares at $320.
Th, 12 Jan 2023
Supply, Demand, & Prices
Enough data points are in: the Fed can (and will) take their foot of the gas
The never-ending blather in the press about the Fed’s tightening cycle has been painful to watch and listen to. We would argue that roughly half of the concerns expressed have been made up by the press itself. Had they simply chosen to adopt the real story (“Rates are at zero; the Fed must raise them to a responsible level to control inflation”) instead of crafting faulty narratives, we don’t believe the markets would have seen the same level of destruction in 2022. So, without regard to what the narrative du jour may be, let’s look at the facts with respect to inflation and rates.
Yet another strong data point came in with Thursday’s CPI report. The cost of living dropped 0.8%—a contraction not seen since April of 2020 during the early days of the pandemic—and the annual rate of inflation fell for a sixth-straight month—to 6.45% from a high of 9.1% last summer. If everyone knows that Fed adjustments have a lag, why has the press been freaking out investors since the hikes began? This downward pressure on inflation is precisely what we expected to see take place, and it is evidence that the hikes are having their desired effect. The unemployment rate may not be going up, but (wonderfully) that is not needed, as wages are finally cooling.
The price of groceries barely budged in December, and gas prices fell over 9%. The cost of shelter remains a major sticking point, as rents jumped 0.8% in the month and mortgage rates remain substantially higher than they were a year ago. Still, several Fed governors gave a nod to the positive report and indicated a slowing of hikes is probably warranted. That was enough to help the markets cobble together a steadily positive day.
Here is what we see happening: The Fed will hike rates just 25 basis points on the 1st of February, another 25 bps in the middle of March, and then halt—putting the upper band of the federal funds rate at 5%. Despite what investors may think, there will be no tightening due to any recession in 2023. Rather, the Fed will sit on that 5% rate for some time. That is not only what we expect, it is also what we want. It is time to start reining in wanton behavior and reduce the Fed’s balance sheet. Maybe we can even hold the $32 trillion national debt steady for a while (insert laugh track here).
Tu, 10 Jan 2023
Government Watchdog
The government is coming for your gas stove
Before you label this story hyperbole, consider this: the city of Los Angeles has already banned gas appliances from being placed in new homes, and the state of California is trying to pass the same law. Let’s consider what is going on at the federal level. You may be familiar with the name Richard Trumka. Before his death last year, Trumka was an organized labor leader and head of the AFL-CIO. In 2021, President Joe Biden appointed his son, Richard Trumka Jr., to head up the US Consumer Product Safety Commission. As with the partisan hack Lina Khan at the FTC, Trumka has turned the CPSC into a political tool, which leads us to the gas stove ban.
Under the ruse that gas stoves are a major source of indoor pollution and a health risk, Trumka told Bloomberg that “products that can’t be made safe can be banned.” Adding fuel to the fire, so to speak, senators Corey Booker and Elizabeth Warrant back the ban, arguing that Black, Latino, and low-income households bear the brunt of this national health crisis, as they do not have the means to properly ventilate their homes. Never mind the economic impact on these lower-income households, considering how much cheaper it is operate gas stoves as opposed to their electric counterparts.
This type of government overreach is both despicable and predictable. When government agencies are not held accountable by the people they supposedly represent, they are able to get away with outrageous acts. Hopefully, there will be a large enough outcry to stop this ban from taking place, but it clearly shows the arrogance of the elite ruling class. We would expect nothing less from a Trumka.
Oddly (not), the press has been quite mum on this topic. Since these individuals purport to be the spokespeople of the disenfranchised, why don’t we take a poll among ordinary Americans in the inner cities and ask them—without mentioning who proposed the ban—whether or not they support this decree? We are fairly sure how they would respond. (Around 35% of American households cook with gas stoves.)
Mo, 09 Jan 2023
Global Strategy: The Americas
Thawing of relations: Chevron shipping 500,000 barrels of oil from Venezuela
Any hopes of helping depose Hugo Chavez’ hand-picked successor in Venezuela, Nicolas Maduro, appear dashed; time to start exporting Venezuelan crude. The Biden administration granted an expanded license to oil giant Chevron (CVX $177) for the purpose of opening back up the supply of oil from Venezuela to the US and other western nations. The first tanker, in fact, has already picked up its load. After four years of sanctions which have done little to change the political dynamic in the country, the administration is trying another tack.
The amount of money Chevron might make out of the deal will be constricted due to the terms of the license; but, considering the billions of dollars owed by the PDVSA—Venezuela’s state-owned oil agency—to the company, it has little to lose. From the US government’s standpoint, the idea is to slowly increase ties with the nation in return for political reform and “free and fair” elections to be held later this year. As for the heavy crude, it is headed to refineries on the US Gulf Coast. The European Union has also been granted an exception for receiving Venezuelan oil to help offset the losses from the Russian embargo. The South American nation has the world’s largest proven oil reserves—some 35 billion more barrels, in fact, than Saudi Arabia.
The way the people of Venezuela are suffering, this is the best possible course of action for the US to take. Eventually, the citizenry will force change; the more draconian our approach to the country, the easier it will be for the Maduro administration to make the US a scapegoat for the economic turmoil.
Mo, 09 Jan 2023
Application & Systems Software
Lessons from Salesforce: If your company gets acquired, your job is not safe
In 2018, relationship management software company Salesforce (CRM $140) bought data integration firm MuleSoft for $6.5 billion. The following year it purchased data visualization company Tableau for $15.3 billion. Two years later, it purchased the business messaging platform Slack for a whopping $27.7 billion. Salesforce CEO Marc Benioff has an appetite as large as his ego, which should have served as a warning to the employees he gobbled up in the deals.
Salesforce has been crushed by the tech reckoning, with its shares trading down 55% from their bloated highs. Benioff, who made $28.6 million last year, is now taking it out on his staff by laying off 10% of the workforce—gutting the companies he accumulated on his wanton buying spree. In a memo to employees, Benioff said the company simply hired too many workers during the pandemic. That is no doubt true, but the ill-conceived acquisitions lie directly at the feet of Benioff, not an economic slowdown. As for those let go due to the CEO’s miscalculations, most were notified via blast emails stating that their positions had been eliminated. That is rich considering the company’s stated corporate culture revolves around the “concept of Ohana,” a Hawaiian term for taking care of one another through a family bond.
We have seen CEOs like Benioff many times over the past generation: blowhards who are never wrong and who run their company like a personal plaything. Workers at such firms must always be ready to face personal and professional upheaval.
Th, 05 Jan 2023
Specialty Retail
Bed Bath & Beyond expresses “substantial doubt” about future, shares plunge
Nine years ago, Bed Bath & Beyond (BBBY $2) was a $17 billion company with shares trading in the $80 range. Five short months ago, shares had rallied back into the $23 range as investors grew more optimistic that the company could pull out of its funk. Those hopes were dashed this week after the company said it was unable to file its Q3 report on time, expressing “substantial doubt about the company’s ability to continue.” That vote of no confidence from management sent shares tumbling 23% at the open, hitting an all-time low of $1.82.
What’s next for the specialty retailer, which now has a market cap of under $150 million? Bankruptcy protection, more than likely, will be the ultimate answer. The company could also attempt to restructure its debt, which might be difficult considering its 300% debt/equity ratio (it has some $1.7 billion in liabilities). Unaudited Q3 results point to sales of around $1.3 billion, down 33% from the same quarter last year, which the company attributes to slower traffic and reduced inventory levels. The latter is a real issue, as suppliers are reluctant to provide hard goods to a company which may not be able to pay them. Analysts had been expecting a net loss in the third quarter of $158 million; we can expect real losses to come in at more than double that figure. The more we look at the financials, the harder it becomes to see any exit strategy outside of bankruptcy protection.
It would be nice to see Bed Bath & Beyond purchased by a private equity firm and taken private, with a continued bricks-and-mortar footprint, but that may be wishful thinking. There is another aspect to this story for investors to be aware of: A dozen REITs report the company as a tenant, with Kimco Realty (KIM $21) holding a plurality of the leases. We have been warning investors about the challenges facing office and retail REITs going forward, and we believe the market is still underestimating the risk. Now is the time to review your real estate holdings.
Headlines for the Month of December, 2022
Th, 22 Dec 2022
Goods & Services
Third quarter GDP revised up to 3.2% on the back of strong consumer spending
For all of the talk about recession, the third quarter of 2022 continues to look stronger in the rear-view mirror. The initial GDP figures showed a 2.6% growth rate, which was subsequently upgraded to 2.9%, and most recently to 3.2%. This is an especially welcome revision following a contraction in each of the first two quarters of the year. The Department of Commerce report reveals strong consumer spending—especially in services such as travel and recreation—over the three-month period, and stronger-than-expected nonresidential fixed investment (think expenditures by firms on capital such as commercial real estate, tools, machinery, and factories). Defense spending also helped grow the economy. An increase in exports and a decrease in imports led to a contraction in the US trade deficit, yet another positive factor. On the flipside, the higher price of both new and used cars constrained growth, as did a drop in new and used home sales.
Ironically, the upward revision in GDP led to a selloff in stocks, as investors see the report as another excuse for the Fed to keep raising rates. We don’t buy that, and still see two more 25-basis-point hikes (bringing the Fed funds rate to 5%) and then an elongated pause.
Th, 22 Dec 2022
Media & Entertainment
The chicanery rolls on at AMC, with an APE conversion and a reverse stock split
AMC Entertainment (AMC $5) is the gift that keeps on giving; well, unless you are an investor in the small-cap theater chain. Remember when Adam Aron’s company issued preferred shares under the apropos symbol APE this past August (at $6.95) and began handing them out to shareholders as dividends? How about when the company toyed with the idea of handing out NFTs as dividends? We sit about twenty minutes away from AMC’s international headquarters, yet Adam Aron, CEO and financial engineer extraordinaire, sits in his office some 1,100 miles away as the crow flies. That about sums it up.
Now, with APE trading at $1.20 (a 75% gain from the prior day) and AMC sitting at $4.50 per share (down 13% on the news), the company announced yet another capital raise ($110 million this time) and a one-for-ten reverse split proposal. Aron tweeted something to the effect of needing to attack the Wall Street haters who are determined to turn AMC into a penny stock. Um, that’s all you, buddy. Such a joke. Aron wanted to attract Apesters by offering a low stock price; now he supposedly wants to attract institutional investors by making the shares worth $50? What institutional investor in their right mind would buy into this horror show? He has turned AMC into his own personal Rube Goldberg machine. He ended his tweet with the sentence, “Simple arithmetic, if approved, the share count goes down so share price goes up.” Gee, thanks for that wonderful lesson in investment finance.
We have always wanted AMC to succeed, but this huckster needs to go. Investors simply need to look at the company’s financials to realize this fact. Stop the games and focus on new and creative ways to fill your theaters.
Mo, 19 Dec 2022
Aerospace & Defense
L3Harris wants to buy Aerojet Rocketdyne, but will the FTC’s Darth Vader kill the deal?
Recall back in February of this year that the FTC’s very own Darth Vader, the highly unqualified Lina Khan, killed Lockheed Martin’s (LMT $482) deal to buy rocket maker Aerojet Rocketdyne (AJRD $55) for $4.4 billion (we own both LMT and AJRD in Penn strategies). Now, US defense contractor L3Harris Technologies (LHX $208) has announced its own agreement to buy the company. L3 has offered $58 per share, or roughly $4.7 billion, to buy the El Segundo-based firm, with the firm’s CEO, Chris Kubasik, outlining a plan to become an alternative supplier to the Pentagon. Just a few months ago, L3 acquired Viasat’s military communications unit, creating the 6th-largest US defense contractor in the process.
While Khan probably would have wished for a foreign entity to buy this American jewel, she is going to have a tough time stopping this acquisition. Her FTC has already lost an inordinate number of battles in the courtroom (she received her law degree just five years ago), and she would have a tenuous argument that the merger would quell competition—though we still expect her to sue. As for the deal itself, we love it. As much as we wanted Lockheed to buy the company, Aerojet would be a great compliment to L3’s existing defense units.
While we don’t own L3Harris outright, it is the seventh-largest holding in our Invesco Aerospace & Defense ETF (PPA $77). With its 16 forward P/E and strong position in the military communications business, it would be a sold addition to a portfolio short on industrials. As could be expected, it is trading slightly down on the acquisition news.
Sa, 10 Dec 2022
Week in Review
Week in Review: The markets dropped on pure silliness
It is the question that just won't die: When will the Fed stop raising rates and what will the terminal rate be? Pure silliness. All of the major indexes fell this week on these concerns, capped off on Friday with a stronger-than-expected Producer Price Index (PPI) for November of 0.3% versus the 0.2% anticipated. The PPI measures inflation from the seller's perspective. There was only one positive day—Thursday—for the markets out of the five sessions.
Here's why we call this pure silliness: The Fed will probably raise rates another 50 basis points this coming week, followed by (in our estimate) two subsequent 25-basis-point hikes in early 2023. That would bring the upper band of the Fed funds rate to 5%. Not 12%, not 10%, not even 7%, but 5%! The economy can grow at a healthy clip with a 5% rate, period. In fact, the historical average of the Fed funds rate is 4.6%. And yes, all of these rate hikes will work their way through the system soon and cause inflation to drop and the unemployment rate to rise—probably closer to 5% from the current 3.7%. What does the Fed consider full employment? 4-6% or less. The markets have overreacted yet again.
Something did drop last week which brought welcome news. Crude oil futures began the week at $80.34 per barrel and ended the week at $71.58 per barrel, or an 11% slide. Astonishingly, considering the Russian oil embargo and OPEC+ production cuts, crude prices are now below where we started the year ($75.45/bbl).
Next week two big stories should dominate the markets: Tuesday's CPI report (what consumers pay for a basket of goods) and Wednesday's rate hike decision. Barring any major surprises in the CPI report, we stick with our 0.5% rate hike prediction. If Powell says the right things in the post-decision news conference, we might just be in for a three-week rally to close out an ugly, ugly year.
Fr, 09 Dec 2022
Government Watchdog
The imperial FTC will lose in court, Microsoft will buy Activision Blizzard
We cannot say enough rotten things about current chair of the Federal Trade Commission, Lina M. Khan. She is highly unqualified for her position, a political hack with a giant chip on her shoulder, a tool for progressives…we will stop there before we make it personal. The most recent target of the FTC, which is now as anti-capitalist as it has ever been, is Microsoft (MSFT $247); specifically, the company’s bid to acquire electronic gaming company Activision Blizzard (ATVI $75) for $69 billion.
Well before the agency announced its lawsuit against Microsoft to block the acquisition, we knew the legal action was coming—Khan is as transparent as cellophane wrap. Microsoft’s management team knew it as well and threw down the gauntlet earlier in the month. Instead of genuflecting before the mighty body the company did just the opposite: it offered nothing and promised a bloody fight. A smart move, as the lawsuit has no merit.
The FTC claims the acquisition would stifle the competition, which is laughable considering the level of creative genius within the world of content creators and the number of Activision’s competitors, to include: Electronic Arts, Take-Two Interactive, Epic Games, Ubiosoft, and Tencent Games. Activision CEO Bobby Kotick echoed Microsoft’s comments: “…I want to reinforce my confidence that this deal will close…we’ll win this challenge.” What do investors think? The day of the lawsuit’s announcement, ATVI shares were down just 1.54%.
The judicial system within the US is becoming so political that it is hard to know for sure what the ultimate outcome of this case will be, but if it is weighed by the merits of the case, the FTC’s lawsuit will be dismissed. We believe Microsoft, which is a member of the Penn Global Leaders Club, will win in court and this intelligent tactical acquisition will transpire—perhaps just a bit behind schedule.
Th, 08 Dec 2022
Judicial Watch
The despicable acts of Michael Avenatti
The first time we saw so-called celebrity lawyer Michael Avenatti we immediately thought, “arrogant (expletive).” At the time, he was considering gracing the country with a run for president. And why not? That seemed about par for the course. Now, several years later, we finally get a bit of schadenfreude. When this California-based legal professional wasn’t busy rushing to the cameras with the likes of porn star Stormy Daniels, he was hard at work defrauding helpless clients. And evading taxes. And trying to extort $25 million from Nike. And committing domestic violence. It now appears that if the reprobate wants to run for president again, it won’t be any sooner than the 2034 election cycle: US District Judge James Selna just threw a 14-year sentence at him, to run concurrently with the term he began serving in 2020. One of Avenatti’s lawyers proclaimed the sentence to be “off-the-charts harsh.”
This person committed so many unfathomable acts it would take a 500-page book to detail all of them, but let’s consider the case of paraplegic Geoffrey Johnson. Avenatti represented the mentally handicapped Johnson in a lawsuit against the County of Los Angeles, alleging that he garnered his injuries as a result of being denied his Constitutional rights (Johnson had jumped off a balcony at the Twin Towers Correctional Facility in LA, causing his injuries). Fearful of the lawsuit going to court, the county did precisely what Avenatti knew they would—pay a $4 million settlement to end the case. Within four months, the settlement funds—which had been placed in his law firm’s trust account—had been drained by the California lawyer. He even financed a new business venture, a coffee company, with the stolen money. Instead of simply taking his confiscatory fee from Johnson, he concealed the settlement from his client and magnanimously paid the man’s monthly assisted living expenses. He subsequently hid income from the government on his business, Tully’s Coffee, and impeded the IRS’s efforts to collect $3.2 million in unpaid payroll taxes.
There are dozens upon dozens of similar stories surrounding Avenatti, and we imagine he will demand payment for the movie which will ultimately be made about him. As for Stormy Daniels, she decided to write a memoir of her travails. In a case of aggravated identity theft, Avenatti stole the $300,000 book advance.
There is so much about the American justice system that has nothing to do with justice and everything to do with greed. In 2020, the State Bar of California finally yanked Avenatti’s license to practice law; where was that esteemed organization in the decades leading up to that point?
Th, 01 Dec 2022
Energy Commodities
License to pump oil in Venezuela is as farcical as tapping the Strategic Petroleum Reserve
The headline intrigued us: “Chevron Gets US License to Pump Oil in Venezuela.” Despite the despot Maduro running the country, we could certainly use more oil to counteract OPEC’s promise to reduce supply and the sanctions on Russian crude. It didn’t take very long, however, before we figured out that this was just another gimmick which would barely move the needle.
The United States produces some 11.7 million barrels per day (BPD) of crude—more than any other country on the planet. Granted, that is down 10% from what we were generating in 2019, but still mighty impressive. While Venezuela does have an enormous store of oil reserves beneath its surface (around 300 billion barrels, or 18% of the world’s known supply), it is only able to pump less than 700,000 BPD—down from 2.3 million BPD in 2016—due to its crumbling energy infrastructure. The deal to resume production, brokered by Norway and signed in Mexico City, is contingent upon the Maduro government implementing a $3 billion humanitarian relief program and holding talks on free elections in the country. Anyone holding their breath on either of those two requirements actually getting accomplished?
But here is where the deal gets really humorous. The Biden administration prohibits pdVSA, the Venezuelan state-owned oil and natural gas entity, from receiving any profits from the oil Chevron sells from the deal; instead, under the new license, all profits will be used to pay off the hundreds of millions of debt owed to Chevron by pdVSA. What, then, is the incentive for Maduro to abide by the agreement and allow Chevron to ramp production back up in the country? That is a good question. Watch for the old bait and switch routine to be pulled. Chevron provides infrastructure, and Venezuela delivers more to China.
Since we are talking oil supplies, let’s revisit the Strategic Petroleum Reserve, the emergency stockpile of oil maintained by the US Department of Energy. It is now down to a disgraceful 400 million barrels from its authorized 727 million barrels. The SPR is sitting there in case of a national emergency, not to reduce the price of oil. So far this year, the administration has released 165 million barrels from the reserve and has announced plans to allow another 15 million barrels to flow. A figurative drop in the bucket with respect to affecting oil prices, but a decision which will impact US readiness. Stop the release and rebuild the supply to authorized levels.
The aim of Venezuela in the Mexico City talks was to get American energy companies back to Venezuela; more specifically, their money, know-how, and equipment. Keep your eyes on this deal, as it will not turn out as expected by those who cobbled it together. Not that we are against more oil production in the Americas; there is nothing more we would like to see than an energy-independent Western hemisphere.
Th, 22 Dec 2022
Goods & Services
Third quarter GDP revised up to 3.2% on the back of strong consumer spending
For all of the talk about recession, the third quarter of 2022 continues to look stronger in the rear-view mirror. The initial GDP figures showed a 2.6% growth rate, which was subsequently upgraded to 2.9%, and most recently to 3.2%. This is an especially welcome revision following a contraction in each of the first two quarters of the year. The Department of Commerce report reveals strong consumer spending—especially in services such as travel and recreation—over the three-month period, and stronger-than-expected nonresidential fixed investment (think expenditures by firms on capital such as commercial real estate, tools, machinery, and factories). Defense spending also helped grow the economy. An increase in exports and a decrease in imports led to a contraction in the US trade deficit, yet another positive factor. On the flipside, the higher price of both new and used cars constrained growth, as did a drop in new and used home sales.
Ironically, the upward revision in GDP led to a selloff in stocks, as investors see the report as another excuse for the Fed to keep raising rates. We don’t buy that, and still see two more 25-basis-point hikes (bringing the Fed funds rate to 5%) and then an elongated pause.
Th, 22 Dec 2022
Media & Entertainment
The chicanery rolls on at AMC, with an APE conversion and a reverse stock split
AMC Entertainment (AMC $5) is the gift that keeps on giving; well, unless you are an investor in the small-cap theater chain. Remember when Adam Aron’s company issued preferred shares under the apropos symbol APE this past August (at $6.95) and began handing them out to shareholders as dividends? How about when the company toyed with the idea of handing out NFTs as dividends? We sit about twenty minutes away from AMC’s international headquarters, yet Adam Aron, CEO and financial engineer extraordinaire, sits in his office some 1,100 miles away as the crow flies. That about sums it up.
Now, with APE trading at $1.20 (a 75% gain from the prior day) and AMC sitting at $4.50 per share (down 13% on the news), the company announced yet another capital raise ($110 million this time) and a one-for-ten reverse split proposal. Aron tweeted something to the effect of needing to attack the Wall Street haters who are determined to turn AMC into a penny stock. Um, that’s all you, buddy. Such a joke. Aron wanted to attract Apesters by offering a low stock price; now he supposedly wants to attract institutional investors by making the shares worth $50? What institutional investor in their right mind would buy into this horror show? He has turned AMC into his own personal Rube Goldberg machine. He ended his tweet with the sentence, “Simple arithmetic, if approved, the share count goes down so share price goes up.” Gee, thanks for that wonderful lesson in investment finance.
We have always wanted AMC to succeed, but this huckster needs to go. Investors simply need to look at the company’s financials to realize this fact. Stop the games and focus on new and creative ways to fill your theaters.
Mo, 19 Dec 2022
Aerospace & Defense
L3Harris wants to buy Aerojet Rocketdyne, but will the FTC’s Darth Vader kill the deal?
Recall back in February of this year that the FTC’s very own Darth Vader, the highly unqualified Lina Khan, killed Lockheed Martin’s (LMT $482) deal to buy rocket maker Aerojet Rocketdyne (AJRD $55) for $4.4 billion (we own both LMT and AJRD in Penn strategies). Now, US defense contractor L3Harris Technologies (LHX $208) has announced its own agreement to buy the company. L3 has offered $58 per share, or roughly $4.7 billion, to buy the El Segundo-based firm, with the firm’s CEO, Chris Kubasik, outlining a plan to become an alternative supplier to the Pentagon. Just a few months ago, L3 acquired Viasat’s military communications unit, creating the 6th-largest US defense contractor in the process.
While Khan probably would have wished for a foreign entity to buy this American jewel, she is going to have a tough time stopping this acquisition. Her FTC has already lost an inordinate number of battles in the courtroom (she received her law degree just five years ago), and she would have a tenuous argument that the merger would quell competition—though we still expect her to sue. As for the deal itself, we love it. As much as we wanted Lockheed to buy the company, Aerojet would be a great compliment to L3’s existing defense units.
While we don’t own L3Harris outright, it is the seventh-largest holding in our Invesco Aerospace & Defense ETF (PPA $77). With its 16 forward P/E and strong position in the military communications business, it would be a sold addition to a portfolio short on industrials. As could be expected, it is trading slightly down on the acquisition news.
Sa, 10 Dec 2022
Week in Review
Week in Review: The markets dropped on pure silliness
It is the question that just won't die: When will the Fed stop raising rates and what will the terminal rate be? Pure silliness. All of the major indexes fell this week on these concerns, capped off on Friday with a stronger-than-expected Producer Price Index (PPI) for November of 0.3% versus the 0.2% anticipated. The PPI measures inflation from the seller's perspective. There was only one positive day—Thursday—for the markets out of the five sessions.
Here's why we call this pure silliness: The Fed will probably raise rates another 50 basis points this coming week, followed by (in our estimate) two subsequent 25-basis-point hikes in early 2023. That would bring the upper band of the Fed funds rate to 5%. Not 12%, not 10%, not even 7%, but 5%! The economy can grow at a healthy clip with a 5% rate, period. In fact, the historical average of the Fed funds rate is 4.6%. And yes, all of these rate hikes will work their way through the system soon and cause inflation to drop and the unemployment rate to rise—probably closer to 5% from the current 3.7%. What does the Fed consider full employment? 4-6% or less. The markets have overreacted yet again.
Something did drop last week which brought welcome news. Crude oil futures began the week at $80.34 per barrel and ended the week at $71.58 per barrel, or an 11% slide. Astonishingly, considering the Russian oil embargo and OPEC+ production cuts, crude prices are now below where we started the year ($75.45/bbl).
Next week two big stories should dominate the markets: Tuesday's CPI report (what consumers pay for a basket of goods) and Wednesday's rate hike decision. Barring any major surprises in the CPI report, we stick with our 0.5% rate hike prediction. If Powell says the right things in the post-decision news conference, we might just be in for a three-week rally to close out an ugly, ugly year.
Fr, 09 Dec 2022
Government Watchdog
The imperial FTC will lose in court, Microsoft will buy Activision Blizzard
We cannot say enough rotten things about current chair of the Federal Trade Commission, Lina M. Khan. She is highly unqualified for her position, a political hack with a giant chip on her shoulder, a tool for progressives…we will stop there before we make it personal. The most recent target of the FTC, which is now as anti-capitalist as it has ever been, is Microsoft (MSFT $247); specifically, the company’s bid to acquire electronic gaming company Activision Blizzard (ATVI $75) for $69 billion.
Well before the agency announced its lawsuit against Microsoft to block the acquisition, we knew the legal action was coming—Khan is as transparent as cellophane wrap. Microsoft’s management team knew it as well and threw down the gauntlet earlier in the month. Instead of genuflecting before the mighty body the company did just the opposite: it offered nothing and promised a bloody fight. A smart move, as the lawsuit has no merit.
The FTC claims the acquisition would stifle the competition, which is laughable considering the level of creative genius within the world of content creators and the number of Activision’s competitors, to include: Electronic Arts, Take-Two Interactive, Epic Games, Ubiosoft, and Tencent Games. Activision CEO Bobby Kotick echoed Microsoft’s comments: “…I want to reinforce my confidence that this deal will close…we’ll win this challenge.” What do investors think? The day of the lawsuit’s announcement, ATVI shares were down just 1.54%.
The judicial system within the US is becoming so political that it is hard to know for sure what the ultimate outcome of this case will be, but if it is weighed by the merits of the case, the FTC’s lawsuit will be dismissed. We believe Microsoft, which is a member of the Penn Global Leaders Club, will win in court and this intelligent tactical acquisition will transpire—perhaps just a bit behind schedule.
Th, 08 Dec 2022
Judicial Watch
The despicable acts of Michael Avenatti
The first time we saw so-called celebrity lawyer Michael Avenatti we immediately thought, “arrogant (expletive).” At the time, he was considering gracing the country with a run for president. And why not? That seemed about par for the course. Now, several years later, we finally get a bit of schadenfreude. When this California-based legal professional wasn’t busy rushing to the cameras with the likes of porn star Stormy Daniels, he was hard at work defrauding helpless clients. And evading taxes. And trying to extort $25 million from Nike. And committing domestic violence. It now appears that if the reprobate wants to run for president again, it won’t be any sooner than the 2034 election cycle: US District Judge James Selna just threw a 14-year sentence at him, to run concurrently with the term he began serving in 2020. One of Avenatti’s lawyers proclaimed the sentence to be “off-the-charts harsh.”
This person committed so many unfathomable acts it would take a 500-page book to detail all of them, but let’s consider the case of paraplegic Geoffrey Johnson. Avenatti represented the mentally handicapped Johnson in a lawsuit against the County of Los Angeles, alleging that he garnered his injuries as a result of being denied his Constitutional rights (Johnson had jumped off a balcony at the Twin Towers Correctional Facility in LA, causing his injuries). Fearful of the lawsuit going to court, the county did precisely what Avenatti knew they would—pay a $4 million settlement to end the case. Within four months, the settlement funds—which had been placed in his law firm’s trust account—had been drained by the California lawyer. He even financed a new business venture, a coffee company, with the stolen money. Instead of simply taking his confiscatory fee from Johnson, he concealed the settlement from his client and magnanimously paid the man’s monthly assisted living expenses. He subsequently hid income from the government on his business, Tully’s Coffee, and impeded the IRS’s efforts to collect $3.2 million in unpaid payroll taxes.
There are dozens upon dozens of similar stories surrounding Avenatti, and we imagine he will demand payment for the movie which will ultimately be made about him. As for Stormy Daniels, she decided to write a memoir of her travails. In a case of aggravated identity theft, Avenatti stole the $300,000 book advance.
There is so much about the American justice system that has nothing to do with justice and everything to do with greed. In 2020, the State Bar of California finally yanked Avenatti’s license to practice law; where was that esteemed organization in the decades leading up to that point?
Th, 01 Dec 2022
Energy Commodities
License to pump oil in Venezuela is as farcical as tapping the Strategic Petroleum Reserve
The headline intrigued us: “Chevron Gets US License to Pump Oil in Venezuela.” Despite the despot Maduro running the country, we could certainly use more oil to counteract OPEC’s promise to reduce supply and the sanctions on Russian crude. It didn’t take very long, however, before we figured out that this was just another gimmick which would barely move the needle.
The United States produces some 11.7 million barrels per day (BPD) of crude—more than any other country on the planet. Granted, that is down 10% from what we were generating in 2019, but still mighty impressive. While Venezuela does have an enormous store of oil reserves beneath its surface (around 300 billion barrels, or 18% of the world’s known supply), it is only able to pump less than 700,000 BPD—down from 2.3 million BPD in 2016—due to its crumbling energy infrastructure. The deal to resume production, brokered by Norway and signed in Mexico City, is contingent upon the Maduro government implementing a $3 billion humanitarian relief program and holding talks on free elections in the country. Anyone holding their breath on either of those two requirements actually getting accomplished?
But here is where the deal gets really humorous. The Biden administration prohibits pdVSA, the Venezuelan state-owned oil and natural gas entity, from receiving any profits from the oil Chevron sells from the deal; instead, under the new license, all profits will be used to pay off the hundreds of millions of debt owed to Chevron by pdVSA. What, then, is the incentive for Maduro to abide by the agreement and allow Chevron to ramp production back up in the country? That is a good question. Watch for the old bait and switch routine to be pulled. Chevron provides infrastructure, and Venezuela delivers more to China.
Since we are talking oil supplies, let’s revisit the Strategic Petroleum Reserve, the emergency stockpile of oil maintained by the US Department of Energy. It is now down to a disgraceful 400 million barrels from its authorized 727 million barrels. The SPR is sitting there in case of a national emergency, not to reduce the price of oil. So far this year, the administration has released 165 million barrels from the reserve and has announced plans to allow another 15 million barrels to flow. A figurative drop in the bucket with respect to affecting oil prices, but a decision which will impact US readiness. Stop the release and rebuild the supply to authorized levels.
The aim of Venezuela in the Mexico City talks was to get American energy companies back to Venezuela; more specifically, their money, know-how, and equipment. Keep your eyes on this deal, as it will not turn out as expected by those who cobbled it together. Not that we are against more oil production in the Americas; there is nothing more we would like to see than an energy-independent Western hemisphere.
Headlines for the Month of November, 2022
We, 30 Nov 2022
Global Organizations & Accords
Better late than never: NATO chief warns against repeating Russian mistake with China
NATO chief Jens Stoltenberg, perhaps the strongest alliance leader since General Alexander Haig back in the 1970s, warned member-states that the critical mistake of relying too heavily on Russia for necessary supplies must not be repeated with China. Of course, that ship has already sailed; for anyone who doubts it, go to the store of your choice and look at the labels on the goods. If it were possible to place an origin sticker on the active pharmaceutical ingredients (APIs) found in our lifesaving drugs, 86% of them would be stamped “Made in China.” Not the drugs, mind you, just the needed ingredients for the drugs. But at least someone in a leadership role is finally standing up and sounding the alarm.
On CNBC this week, the astute reporter Brian Sullivan made the following statement: “It is amazing how many CEOs of American companies have no problem wading into domestic politics but are completely silent with respect to (what is going on in) China. Amen, Brian. Stoltenberg told a group of foreign ministers that, “Over-dependence of resources on authoritarian regimes like Russia makes us vulnerable and we should not repeat that mistake with China. We should assess our vulnerabilities and reduce them.” US Secretary of State Antony Blinken echoed his comments following the meeting. The NATO chief went even further and brought up the topic China “forbids” being discussed. “China’s behavior toward Taiwan is aggressive, coercing, and threatening,” and “any conflict around Taiwan would be in nobody’s best interest.” Could we etch his words in stone and force American CEOs to hang them in their offices?
We have a high level of respect for the likes of Apple’s Cook, Walmart’s McMillon, and Nike’s Donahoe, but they can and should be doing more to migrate away from Chinese manufacturing facilities. Of course, they will tell you they are, but the shelves and the tags still tell a different story. Here’s to Stoltenberg—we will hunt down a Norwegian beer and drink a toast to his leadership.
Tu, 29 Nov 2022
Beverages, Tobacco, & Cannabis
Budweiser’s awesome response to Qatar’s classless move to ban beer
One might question the wisdom of Budweiser’s (BUD $58) decision to sponsor the World Cup in a nation which loathes alcohol, but the InBev unit paid $75 million for the rights. As could be expected, host nation Qatar—cash in hand—then banned all beer sales in and around World Cup stadiums, making the announcement just two days before the tourney began. They did, however, graciously announce that non-alcoholic Bud Zero would still be allowed. How magnanimous. Bud has been the exclusive beer distributor at FIFA World Cup games since 1986, and had previously renewed their contract after receiving assurances from Qatar that beer would be allowed when they hosted the games. Needless to say, InBev and beer drinking attendees were fuming.
We haven’t been the world’s biggest Budweiser fans since the Busch family—specifically Buschies III and IV—lost the company to a foreign entity (InBev) due to egregious mismanagement and stellar arrogance. Nonetheless, their response to Qatar’s slap in the face is worthy of a toast. The company has announced that all of the surplus beer banished from the Islamic state will be hauled to the nation which wins the 2022 World Cup and used as the centerpiece for a massive victory celebration. Bud tweeted: “They…get a victory celebration on us. It’s gonna be big.” Talk about turning a costly indignity into a massive, global PR stunt; brilliant! Trending on Twitter: #BringHomeTheBud. Long live beer!
With the proliferation of great craft beer companies since InBev acquired Anheuser-Busch back in 2008, competition within the industry has been fierce—even for the enormous players like Bud. We last owned BUD in the Penn Global Leaders Club back in 2008 and haven’t really considered adding it back since. Shares seem fairly valued around $65, or just 12% where they now trade. Still, we applaud the hilarious move following Qatar’s deceitful decision. An aside: An odds-on favorite to win the World Cup this year is Brazil, which happens to be one of the two countries (Belgium being the other) which control InBev.
Mo, 28 Nov 2022
Construction Materials
The ultimate contrarian play: Is Builders FirstSource worthy of a look?
Builders FirstSource (BLDR $60) is a pure play on one of the most (if not the most) distressed corners of the market: new home construction. The $9 billion Dallas-based company manufactures and supplies factory-built roof and floor trusses, wall panels and stairs, vinyl windows, custom millwork and trim, and engineered wood products to homebuilders of all sizes. When there is a housing boom underway, investing in the company makes perfect sense; but when the sector moves south, so does its share price. Case in point: Before the 2008 housing crisis, BLDR shares were trading around $25; in December of 2008, they hit $0.83.
While Builders FirstSource certainly isn’t under the strain it was back in 2008, consider this: at $60 per share, the stock has a tiny multiple of 3.7 and a forward P/E of 3.4. Over the trailing twelve months, the company earned $2.8 billion from $23 billion in revenue. Investors may be leery of jumping in, but management is not: the company just boosted its stock buyback program by $1 billion. Between August of last year and prior to this latest buyback, the firm spent a massive $3.8 billion buying back 61 million shares of stock (30% of shares outstanding) at an average price of $63.05. Talk about being bullish on your future.
With a presence in 85 of the top 100 metropolitan markets in the country, and with no single customer accounting for more than 6% of sales, it wouldn’t take much to move Builders FirstSource shares higher. While we don’t currently own the company in any Penn Strategy, we would place a fair value on the shares somewhere in the range of $80 to $100.
Sa, 26 Nov 2022
Market Pulse
Week in review: Markets gained some ground in thin trading
Trading was thin over the holiday-shortened week on Wall Street, but the major benchmarks still managed to pull out a win. The Nasdaq was the laggard, up 0.72% on the week; the S&P 500 was up just over twice that amount, or 1.53%. The one component we wanted to see fall on the week actually did just that: oil dropped 4.44% to $76.55 per barrel. Rather remarkable, considering all the recent talk of OPEC+ production cuts and the impending (05 Dec) full EU ban on Russian oil. Even more stunning is the fact that we are now just 1.46% above where crude started the year: $75.45. Keep in mind that Russia didn't invade Ukraine until February. China announced major lockdowns due to new outbreaks of the pandemic this past week, and we are now just over two weeks from a potential rail strike. Perhaps we are finally witnessing seller exhaustion. The S&P 500 remains 15.5% below where it started the year, while the Nasdaq remains down 28.24%.
We, 23 Nov 2022
Farm & Heavy Construction Machinery
High tech down on the farm: Deere sees ‘total autonomy’ by 2030
Shares of farming construction equipment leader Deere & Company (DE $438) rose 5% on Wednesday following a sterling earnings report. Revenue surged 37% year-over-year, to $15.5 billion, with all major business lines notching big sales increases. With booming commodity prices, farmers are reaping increased cash yields, and they are putting much of that money to work in new equipment. The big sales gains flowed directly down to the bottom line, with profits soaring 75%—to $2.2 billion. As if the actual numbers weren’t enough to make investors swoon, management followed up with strong 2023 projections. CEO John May sees increased investment in infrastructure next year—despite high odds of a recession—and a “healthy demand for our equipment.” Rachel Bach, manager of investor communications, said dealers “remain on allocation” for the year, with the order books already filled into the third quarter.
The company also sees a transformational trend taking root in the industry over the next decade with respect to automation. Deere believes we could see “total autonomy” in corn and soybean production within the US by 2030. Not only does that mean increased sales of new, high-tech equipment, it also means new recurring revenue models. Imagine farmers calling on the company’s AI to identify weeds in the field and spray nutrients with pinpoint accuracy. Consider how important that ability becomes with the sky-high price of agriculture inputs like nitrogen, phosphate, and potash. Deere plans to grow their recurring revenue streams by 10% before the end of the decade—we believe those estimates are conservative.
It's hard to believe it has been two years since we wrote about Deere’s impressive comeback following the brutal downturn during the initial days of the pandemic. At the time, Deere shares were trading for $256, and Morningstar had a fair value of $183 on them along with a one-star (“Sell”) rating. We didn’t agree with their thesis. Today, Deere shares are sitting at $438 and Morningstar has raised its weighting to two stars (“Underweight”) and placed a $354 fair value on the shares. Ditto what we said precisely two years ago—we ardently disagree. Maybe the company should do a 10-for-1 stock split; after all, doesn’t $44 per share sound more appealing to many investors than $438? (We are being facetious, but—sadly—that is how too many investors scour for “undervalued” stocks.)
Mo, 21 Nov 2022
Media & Entertainment
Disney shocker: Hapless Chapek fired as Iger returns to lead the company
It was the move we have been waiting for, but one we thought wouldn’t happen for at least another year. Despite foolishly extending CEO Bob Chapek’s contract by three years, the Walt Disney Company (DIS $100) board did an abrupt about face and fired him. Chapek was clearly in over his head, but the board was stubbornly defiant on the matter. So, why the sudden change of heart? The most recent earnings report, which we wrote about in our last After Hours, was almost certainly the final straw. A revenue miss, an earnings miss, and massive streaming losses pushed Chapek out the door—with no doubt some help from a few Iger phone calls we will never know about. Yes, Iger’s ego is enormous, but who cares? He is probably the one person who can choreograph a quick turnaround. The move was music to our ears. Investors didn’t mind, either: shares were trading up nearly 10% in the pre-market following the announcement.
After leading the company for fifteen years, Bob Iger has “agreed” (more like demanded) to come back for another two years, effective immediately. Despite hand-selecting Chapek to succeed him, one could sense the disdain between the two as of late. Under Iger’s tenure, Disney grew from a theme park juggernaut into a media empire, thanks to four astute acquisitions and the launch of the Disney+ streaming service. Now, instead of resuming his acquisition strategy, he will set about mending the fences in Hollywood which Chapek tore down and maximizing the post-pandemic comeback in his parks and resorts.
There are no systemic reasons why Disney cannot stage an impressive comeback with the right leadership. Streaming may be mega-competitive, but that should worry Netflix (NFLX $291) more than Disney, as the former is a one-trick pony. Despite hefty price increases at the parks, we expect visitors to continue flooding back; and with the company’s impressive media franchises (Pixar, Marvel, Lucasfilm, and 21st Century Fox), the content possibilities seem endless. It is simply time for Iger to perform damage control using a tool Chapek didn’t have: charisma.
We have said repeatedly that we would never re-add Disney to any Penn portfolio while Chapek was CEO. Well, now he is gone. Let the comeback begin.
Th, 17 Nov 2022
Personal Finance
As we near a possible recession, Americans hit a new record of household debt
Let’s put some gargantuan numbers in perspective. The annual US GDP, or the total value of all goods produced and services provided within the country, is currently $25.66 trillion—far and away the largest in the world. Sadly, like the talented athlete with a fat new contract but little financial control, the country is currently $31.26 trillion in debt. The next-largest number is reserved for the US consumer, otherwise known as the world’s golden goose. Despite concerns over a coming recession, household debt in the US just rose at its fastest pace since 2007, bringing the figure up to a whopping $16.5 trillion.
Most disturbingly, credit card balances rose more than 15% from last year, the biggest spike in two decades. Despite the Fed funds rate sitting at 4%, the average credit card carries a 20% interest rate, with the average store-branded credit card charging 26.72%. Total debt jumped $351 billion during the July-through-September period alone—the largest quarterly increase since 2007 as well. Interestingly, the 8.3% year-over-year jump in total debt exactly matches August’s inflation read. While the rate of inflation cooled to 7.7% according to October’s CPI report, something tells us the $16.5 trillion figure will not drop.
In fairness, outstanding mortgage balances account for some $11.7 trillion of the aggregate debt, followed by $1.5 trillion in both auto loan and student loan debt, and $1 trillion worth of credit card balances. The remaining amount consists of mortgage originations, or loans taken out against the value of one’s home. Sadly, many of these loans are initiated to pay down credit card debt; balances which have a tendency to build right back up. These are not good data points going into a turbulent economic period.
As interest rates were low and student loan interest was placed on hold, Americans had the perfect opportunity to draw down their personal debt levels. Many did just that, but too many others decided to wantonly spend despite rising prices. And why not? The government has no problem spending money it does not have.
We, 16 Nov 2022
Space Sciences & Exploration
Furthering US dominance in spaceflight, NASA launches Artemis to the moon
Fifty years almost to the month after Gene Cernan and Harrison Schmitt became the last humans to walk on the moon, NASA is ready to send a new generation of Americans to the lunar surface. At 1:47 a.m. EST the largest and most powerful rocket ever launched lifted off from the Kennedy Space Center, sending the Lockheed Martin-built (LMT $468) Orion crew capsule on its 25-day journey around the moon and back. The Space Launch System (SLS)—part of the Artemis Moon program—has been a massive effort involving a number of aerospace companies, to include Lockheed, Boeing (BA $173), Northrop Grumman (NOC $502), Aerojet Rocketdyne (AJRD $50), and Airbus (EADSY $30).
Orion should reach the moon within six days, passing within sixty miles of the lunar surface before settling into its deep retrograde orbit—a looping route that extends 40,000 miles beyond the moon. That will set a record for the furthest distance from the Earth for any crew-capable ship in the history of human spaceflight. After spending two weeks in orbit, the craft will return home on 11 December with a Pacific Ocean splashdown.
Much like the one-person Mercury, two-person Gemini, and three-person Apollo craft, NASA is taking a step-by-step approach with this program. Artemis 1 will show that the craft can safely ferry astronauts back to the moon; Artemis 2 will carry a crew of astronauts to lunar orbit; Artemis 3 will place Americans back on the moon’s surface. It should be noted that Artemis, in Greek mythology, is the twin sister of Apollo. While remaining on schedule with any crewed space program is always extremely challenging, NASA’s plans call for a landing to take place on the lunar surface as soon as 2025.
The Apollo missions completed one of the greatest achievements in human history; in some ways, however, the Artemis program is even more important. Like our ancestral explorers, the earliest journeys always pave the way for trips designed to settle new lands. Between the six-person Orion capsule and Elon Musk’s Starship, which can be configured to carry a crew of up to 100, it is fair to say that we are entering the most exciting phase of our nascent journey into space. NASA has, in fact, already tapped SpaceX and its Starship for the second lunar landing program. We own all of the companies listed in this story other than Boeing. Despite SpaceX being privately held, we own that company via a private equity fund within the Penn Dynamic Growth Strategy.
Mo, 14 Nov 2022
Homebuilding
Lennar is building a 3D-printed community in the suburbs of Austin, Texas
It seems like something out of a science fiction novel, but it is happening in our own backyard right now. America’s second-largest homebuilder, Lennar (LEN $87), in partnership with 3D printing company ICON, is developing a 100-home community near Austin, Texas consisting entirely of 3D-printed homes. The community will offer buyers a selection of eight floorplans and 24 unique elevations ranging from 1,574 to 2,112 square feet of living space. The three to four bedroom, two to three bath homes will be partially powered by rooftop solar panels and come with a price tag starting in the mid-$400,000 range.
The 3D printers creating the homes are nothing short of remarkable. Designed to operate 24 hours per day, they are fully automated with just three workers needed at each home site. The ICON machines build the entire wall system of the house, to include electrical and plumbing, three times faster than traditional methods and at around half the cost. The walls are made of concrete, meaning increased strength and excellent energy efficiency. It takes the massive printer about two weeks to “build” (picture toothpaste coming out of a tube) one home. This is the first 3D housing development project to be completed fully on site, but we expect it to be the start of a revolutionary transformation in the homebuilding industry.
There are many fascinating facets to this story, from the innovative robotics involved, to the possible effect of reducing housing inflation, to the impact on the price of building materials (think of the reduction in lumber use within these sites). Lennar remains on the cutting edge of homebuilding innovation, and is our favorite player in the space.
Sa, 12 Nov 2022
Market Pulse
Week in Review: Markets dropped after the election, soared on inflation data
There were two big potential catalysts for the stock market this past week: the mid-term elections and the CPI report. Following Tuesday’s mixed election results, investors decided it was time to sell; the major benchmarks all dropped in the 2% range. We were worried that Thursday’s CPI report, which gauges the rate of inflation in the US, would provide another excuse to keep the risk-off train moving. Instead, the rate of growth of inflation actually slowed to levels not seen since January, and it was off to the races. While led by the Nasdaq and small-cap Russell 2000, which were up 7.35% and 6.11% on the day, respectively, the S&P 500 and Dow also roared into the close. For the S&P 500 to move 5.54% in any given session is mighty impressive. Instead of taking some profit off the tables on Friday, investors followed up with another nice move higher. Everyone who finally threw the towel in on big tech names like Apple (AAPL), Microsoft (MSFT), and Google (GOOGL) paid a steep price this week: all were up nicely, with the latter two jumping 11.5% on the week. Good news also came with the price of crude, which fell 4% over the five sessions, dropping to an eight-handle. Both the ten-year and two-year Treasury yields fell more than 8% on the week.
Of all the market statistics from this past week, we find the Treasury rate change most interesting. The 2-year tends to predict what the Fed will do next, while the 10-year is more tethered to the 30-year mortgage rate. The plunge in the 2-year Treasury yield, from around 4.7% on Monday to 4.324% on Thursday (the bond market was closed on Veterans Day), signals a smaller rate hike might be in the cards for December’s FOMC meeting—at least in the minds of investors. We shall see—there remains a hawkish tone among the Fed governors.
Fr, 11 Nov 2022
Cryptocurrencies
Once called the JP Morgan of crypto, Sam Bankman-Fried’s wealth evaporates
Sam Bankman-Fried, the wonder boy of the crypto world who built the world’s second-largest crypto exchange, is finished. Were his FTX publicly traded, it would have probably garnered a market cap in the $20 billion ballpark a few weeks ago; now, the company has announced bankruptcy plans and Fried has resigned as CEO. The FTX token, which was selling for $80.50 in September of last year, is now going for $2.77 (down 60% in one day) and is probably worth a lot less than that. The wunderkind who went in front of Congress earlier in the year to explain the 2008 financial crisis—and how his exchange is completely different—was apparently using customer assets to fund ultra-high-risk bets by Alameda Research, a now-defunct quant trading firm majority-owned by Fried. High profile investment entities, from Softbank to Sequoia Capital to the Ontario Teachers’ Pension Plan, will lose virtually all the money they entrusted to FTX. Of course, their investment losses pale in comparison to Bankman-Fried’s personal erosion of wealth, which has dissolved from a high of around $16 billion to well under $1 billion today. But if a loss of wealth is all he suffers in the end, the JP Morgan of crypto should thank his lucky stars.
Highly sophisticated investors—and millions of everyday Joes—were wantonly pumping money into speculative vehicles which weren’t quite as transparent as the likes of Fried led them to believe. This was gambling, not investing. Ironically, Fried was seen as crypto’s white knight, riding to the rescue of “weaker” players. It appears he was doing so with money that didn’t belong to him. If this had to happen (and it did), it is a good thing that it came to light now—crypto had already been so pummeled that the contagion effect is relatively muted. Except, that is, for the investment houses like Softbank, which reportedly will lose some $100 million on the liquidation.
Th, 10 Nov 2022
Supply, Demand, & Prices
Finally! Inflation shows signs of cooling and the market’s reaction is intense
In normal times, a 7.7% year-over-year inflation reading would send the markets reeling. Instead, the latest CPI report led directly to a 1,201-point-gain in the Dow (3.7%), a 208-point-gain in the S&P 500 (5.54%), and an explosive 761-point-gain in the Nasdaq (7.35%). Those remarkable, one-session returns occurred thanks to slowest y/y inflation rate since January. This past June, the 9.1% reading marked the highest rate of inflation in the US in four decades. September’s report wasn’t much better, coming in at 8.2%. Breaking the report down, core CPI—which excludes food and energy—came in at 6.3%, which signaled another slowdown in growth from the previous months. October’s jobs numbers also gave the doves a ray of hope that the current hiking cycle may be on its last legs: the US unemployment rate rose from 3.5% to 3.7%. Wage growth is also easing, going from 5% y/y in September to 4.7% in October. No Fed officials came out and applauded the CPI report, but investors certainly celebrated by giving the market its best day in over two years.
While a 75-bps-hike is still expected at the December FOMC meeting, the odds of a smaller, 50-bps-hike are rising. Were the latter to happen, it would probably spell a serious Santa Claus rally going into the last few weeks of the year.
We, 09 Nov 2022
Media & Entertainment
Disney falls another 11% after dismal earnings report
We wrote a scathing indictment of Disney’s (DIS $88) management team this past spring, stating that CEO Bob Chapek must go. At the time, Disney shares had plunged to $138, down from $203. The latest drop—11% at the open—came in response to another bad earnings report. Revenues were a miss; earnings were a miss; streaming losses widened. While Disney+ added 12.1 million new accounts in the quarter, that business lost a whopping $1.47 billion. Since it launched back in 2019, the streaming service has now lost some $8 billion in aggregate. The parks have been doing great, but that is a huge deficit to keep covering. After spending $30 billion on content over the past twelve months alone, management announced cuts were coming to the content and marketing budgets but gave no specifics. Disney’s bottom-line numbers for the quarter say it all: Against expectations for $788 million in net income, the company made just $162 million. At least they remained in the black.
Analysts have overwhelmingly been bullish on this stock all year, projecting a big comeback in the share price. Considering Chapek just received a three-year contract extension, even $88 per share does not look attractive to us. What was the board thinking?
Th, 03 Nov 2022
Hotels, Resorts, & Cruise Lines
Airbnb is trading in double-digits again; is the stock worth a look?
Despite pricing its initial public offering shares at $68, the typical Joe had to buy Airbnb (ABNB $94) shares on the open market back in December of 2020. For anyone who wanted to jump into this highly touted travel name at the open (like us), the price was steep: shares opened at $146 and remained in triple digits for over a year. Now, investors can get in for the “bargain price” of just $94 per share—36% cheaper than the opening-day price. But are the shares actually cheap?
The company just had its “biggest and most profitable quarter ever,” with revenue of $2.9 billion and adjusted earnings of $1.5 billion. Gross bookings rose 31% in the quarter, beating estimates. Why, then, did ABNB shares plunge nearly 20% this week? It all revolves around guidance. For Q4, management expects revenue in the $1.85 billion range and growth of around 25%, “consistent with historical seasonality.” CEO Brian Chesky said the company is well positioned for the road ahead and has taken steps to reduce costs in preparation for a tougher economic environment. As with Powell’s comments on rate hikes, investors seemed to contort the words to paint a darker view of what’s to come. Hence, the major price drop.
In its “Airbnb 2022 Summer Release,” the company announced a slew of enhancements which would amount to “the biggest change to Airbnb in a decade,” according to Chesky. From an enhanced app experience to new protections for both guests and hosts, these upgrades should keep the company well ahead of its competitors in the space. While they are being attacked from both sides—the online travel agencies (to include Booking and Expedia) and the major hotel chains (primarily Hilton and Marriott)—the $60 billion firm controls approximately one-fifth of the entire vacation rental market. Considering the value of that market is projected to exceed $100 billion within five years, simply maintaining their ratio would spell strong growth ahead for the company. Investors are not in the mood, however, to give any consumer discretionary name a benefit of the doubt right now. Shares have fallen 43% year to date.
With its forward P/E of 32, Airbnb’s valuation remains richer than its online travel competitors and roughly in line with the major hotel chains. While we aren’t ready to add the company to a portfolio, the price seems to be at the upper end of the “fair” range. Should the shares fall closer to the IPO offering price of $68, we would almost certainly jump in.
We, 02 Nov 2022
Interactive Media & Services
Monetizing Twitter: Elon announces a new price plan for Twitter Blue
We were familiar with the blue checkmark symbol next to the name of Twitter users, but we never really gave much thought to who gets one and who does not. Introduced in 2009, this verification system was meant to provide a level of validity to notable account holders, such as celebrities, brands, and organizations. Sort of a caste system on the platform to separate the gentry from the hoi polloi, or unwashed masses. Elon Musk, self-proclaimed Chief Twit, is not a fan of such hierarchies, and he sent out a great tweet indicating what he thought of the policy: “Twitter’s current lords and peasants system for who has or doesn’t have a blue checkmark is bulls***. Power to the people! Blue for $8/month.”
Twitter Blue has been a subscription-based service which allows users to edit tweets, organize them into folders, and access other member-only perks. While Twitter has some 300 million daily active users and generated $5 billion in revenue last year, only around 424,000 accounts hold the coveted blue checkmark. Elon Musk has a grand vision for Twitter, and monetizing the platform is paramount. While the fee would go up to $8 per month, qualified users would be virtually guaranteed of receiving the verification stamp, and we can certainly expect Musk to roll out more perks in the months to come. His ultimate goal is to create what he calls “X, the everything app.” This “super app” would include social media interaction, messaging, payments, and even the ability to order food and drinks. Doubters abound, just as they did with Tesla in the early days, and some companies are indicating they may stop advertising on the platform. They will end up on the wrong side of this story after Musk is done writing it.
This past Friday, we saw a tweet which read: “Twitter hasn’t been this much fun in years.” Despite the naysayers, we fully expect Musk to transform what the platform is today into something quite different—and much more powerful. Some users and advertisers won’t come back, but we doubt the new owner, with his “move fast and break things” mentality, will give them a second’s worth of thought.
Tu, 01 Nov 2022
Transportation Infrastructure
Uber shares spike after the company reports beat on sales, strong ridership growth
A few weeks ago, shares of Penn New Frontier Fund member Uber (UBER $31) fell sharply on news that the Biden administration wanted to force gig economy companies to reclassify drivers as employees rather than freelancers. At the time, we believed that drop was a mistake, as there is very little chance the plan would ever see the light of day. That would have been a good time to get into the ridesharing company. Shares spiked over 15% mid-week as the company reported a staggering 72% jump in sales—to $8.34 billion—from the same quarter in 2021. Gross bookings rose 26%, to $29.1 billion, and adjusted EBITDA came in at $516 million—another beat. Uber Eats, the food-delivery unit of the company, now accounts for one-third of Uber’s total revenue mix.
In addition to the sales beat, Uber CEO Dara Khosrowshahi said he is quite optimistic about the fourth quarter, adding that even lower-income riders are increasing their ridership despite looming recession fears. He projects $600 million in adjusted earnings over the course of the quarter. As for the worker shortage, Uber’s global driver base is now back to pre-pandemic levels.
We have stuck with Uber through the horrendous 2022 downturn because we believe in the company’s growth trajectory. By building out a suite of delivery services, the company has insulated its business (to a good degree) from cyclical economic downturns. Additionally, the industry has a rather wide moat, and Uber is the clear leader in the space. We maintain our $70 price target on the shares.
We, 30 Nov 2022
Global Organizations & Accords
Better late than never: NATO chief warns against repeating Russian mistake with China
NATO chief Jens Stoltenberg, perhaps the strongest alliance leader since General Alexander Haig back in the 1970s, warned member-states that the critical mistake of relying too heavily on Russia for necessary supplies must not be repeated with China. Of course, that ship has already sailed; for anyone who doubts it, go to the store of your choice and look at the labels on the goods. If it were possible to place an origin sticker on the active pharmaceutical ingredients (APIs) found in our lifesaving drugs, 86% of them would be stamped “Made in China.” Not the drugs, mind you, just the needed ingredients for the drugs. But at least someone in a leadership role is finally standing up and sounding the alarm.
On CNBC this week, the astute reporter Brian Sullivan made the following statement: “It is amazing how many CEOs of American companies have no problem wading into domestic politics but are completely silent with respect to (what is going on in) China. Amen, Brian. Stoltenberg told a group of foreign ministers that, “Over-dependence of resources on authoritarian regimes like Russia makes us vulnerable and we should not repeat that mistake with China. We should assess our vulnerabilities and reduce them.” US Secretary of State Antony Blinken echoed his comments following the meeting. The NATO chief went even further and brought up the topic China “forbids” being discussed. “China’s behavior toward Taiwan is aggressive, coercing, and threatening,” and “any conflict around Taiwan would be in nobody’s best interest.” Could we etch his words in stone and force American CEOs to hang them in their offices?
We have a high level of respect for the likes of Apple’s Cook, Walmart’s McMillon, and Nike’s Donahoe, but they can and should be doing more to migrate away from Chinese manufacturing facilities. Of course, they will tell you they are, but the shelves and the tags still tell a different story. Here’s to Stoltenberg—we will hunt down a Norwegian beer and drink a toast to his leadership.
Tu, 29 Nov 2022
Beverages, Tobacco, & Cannabis
Budweiser’s awesome response to Qatar’s classless move to ban beer
One might question the wisdom of Budweiser’s (BUD $58) decision to sponsor the World Cup in a nation which loathes alcohol, but the InBev unit paid $75 million for the rights. As could be expected, host nation Qatar—cash in hand—then banned all beer sales in and around World Cup stadiums, making the announcement just two days before the tourney began. They did, however, graciously announce that non-alcoholic Bud Zero would still be allowed. How magnanimous. Bud has been the exclusive beer distributor at FIFA World Cup games since 1986, and had previously renewed their contract after receiving assurances from Qatar that beer would be allowed when they hosted the games. Needless to say, InBev and beer drinking attendees were fuming.
We haven’t been the world’s biggest Budweiser fans since the Busch family—specifically Buschies III and IV—lost the company to a foreign entity (InBev) due to egregious mismanagement and stellar arrogance. Nonetheless, their response to Qatar’s slap in the face is worthy of a toast. The company has announced that all of the surplus beer banished from the Islamic state will be hauled to the nation which wins the 2022 World Cup and used as the centerpiece for a massive victory celebration. Bud tweeted: “They…get a victory celebration on us. It’s gonna be big.” Talk about turning a costly indignity into a massive, global PR stunt; brilliant! Trending on Twitter: #BringHomeTheBud. Long live beer!
With the proliferation of great craft beer companies since InBev acquired Anheuser-Busch back in 2008, competition within the industry has been fierce—even for the enormous players like Bud. We last owned BUD in the Penn Global Leaders Club back in 2008 and haven’t really considered adding it back since. Shares seem fairly valued around $65, or just 12% where they now trade. Still, we applaud the hilarious move following Qatar’s deceitful decision. An aside: An odds-on favorite to win the World Cup this year is Brazil, which happens to be one of the two countries (Belgium being the other) which control InBev.
Mo, 28 Nov 2022
Construction Materials
The ultimate contrarian play: Is Builders FirstSource worthy of a look?
Builders FirstSource (BLDR $60) is a pure play on one of the most (if not the most) distressed corners of the market: new home construction. The $9 billion Dallas-based company manufactures and supplies factory-built roof and floor trusses, wall panels and stairs, vinyl windows, custom millwork and trim, and engineered wood products to homebuilders of all sizes. When there is a housing boom underway, investing in the company makes perfect sense; but when the sector moves south, so does its share price. Case in point: Before the 2008 housing crisis, BLDR shares were trading around $25; in December of 2008, they hit $0.83.
While Builders FirstSource certainly isn’t under the strain it was back in 2008, consider this: at $60 per share, the stock has a tiny multiple of 3.7 and a forward P/E of 3.4. Over the trailing twelve months, the company earned $2.8 billion from $23 billion in revenue. Investors may be leery of jumping in, but management is not: the company just boosted its stock buyback program by $1 billion. Between August of last year and prior to this latest buyback, the firm spent a massive $3.8 billion buying back 61 million shares of stock (30% of shares outstanding) at an average price of $63.05. Talk about being bullish on your future.
With a presence in 85 of the top 100 metropolitan markets in the country, and with no single customer accounting for more than 6% of sales, it wouldn’t take much to move Builders FirstSource shares higher. While we don’t currently own the company in any Penn Strategy, we would place a fair value on the shares somewhere in the range of $80 to $100.
Sa, 26 Nov 2022
Market Pulse
Week in review: Markets gained some ground in thin trading
Trading was thin over the holiday-shortened week on Wall Street, but the major benchmarks still managed to pull out a win. The Nasdaq was the laggard, up 0.72% on the week; the S&P 500 was up just over twice that amount, or 1.53%. The one component we wanted to see fall on the week actually did just that: oil dropped 4.44% to $76.55 per barrel. Rather remarkable, considering all the recent talk of OPEC+ production cuts and the impending (05 Dec) full EU ban on Russian oil. Even more stunning is the fact that we are now just 1.46% above where crude started the year: $75.45. Keep in mind that Russia didn't invade Ukraine until February. China announced major lockdowns due to new outbreaks of the pandemic this past week, and we are now just over two weeks from a potential rail strike. Perhaps we are finally witnessing seller exhaustion. The S&P 500 remains 15.5% below where it started the year, while the Nasdaq remains down 28.24%.
We, 23 Nov 2022
Farm & Heavy Construction Machinery
High tech down on the farm: Deere sees ‘total autonomy’ by 2030
Shares of farming construction equipment leader Deere & Company (DE $438) rose 5% on Wednesday following a sterling earnings report. Revenue surged 37% year-over-year, to $15.5 billion, with all major business lines notching big sales increases. With booming commodity prices, farmers are reaping increased cash yields, and they are putting much of that money to work in new equipment. The big sales gains flowed directly down to the bottom line, with profits soaring 75%—to $2.2 billion. As if the actual numbers weren’t enough to make investors swoon, management followed up with strong 2023 projections. CEO John May sees increased investment in infrastructure next year—despite high odds of a recession—and a “healthy demand for our equipment.” Rachel Bach, manager of investor communications, said dealers “remain on allocation” for the year, with the order books already filled into the third quarter.
The company also sees a transformational trend taking root in the industry over the next decade with respect to automation. Deere believes we could see “total autonomy” in corn and soybean production within the US by 2030. Not only does that mean increased sales of new, high-tech equipment, it also means new recurring revenue models. Imagine farmers calling on the company’s AI to identify weeds in the field and spray nutrients with pinpoint accuracy. Consider how important that ability becomes with the sky-high price of agriculture inputs like nitrogen, phosphate, and potash. Deere plans to grow their recurring revenue streams by 10% before the end of the decade—we believe those estimates are conservative.
It's hard to believe it has been two years since we wrote about Deere’s impressive comeback following the brutal downturn during the initial days of the pandemic. At the time, Deere shares were trading for $256, and Morningstar had a fair value of $183 on them along with a one-star (“Sell”) rating. We didn’t agree with their thesis. Today, Deere shares are sitting at $438 and Morningstar has raised its weighting to two stars (“Underweight”) and placed a $354 fair value on the shares. Ditto what we said precisely two years ago—we ardently disagree. Maybe the company should do a 10-for-1 stock split; after all, doesn’t $44 per share sound more appealing to many investors than $438? (We are being facetious, but—sadly—that is how too many investors scour for “undervalued” stocks.)
Mo, 21 Nov 2022
Media & Entertainment
Disney shocker: Hapless Chapek fired as Iger returns to lead the company
It was the move we have been waiting for, but one we thought wouldn’t happen for at least another year. Despite foolishly extending CEO Bob Chapek’s contract by three years, the Walt Disney Company (DIS $100) board did an abrupt about face and fired him. Chapek was clearly in over his head, but the board was stubbornly defiant on the matter. So, why the sudden change of heart? The most recent earnings report, which we wrote about in our last After Hours, was almost certainly the final straw. A revenue miss, an earnings miss, and massive streaming losses pushed Chapek out the door—with no doubt some help from a few Iger phone calls we will never know about. Yes, Iger’s ego is enormous, but who cares? He is probably the one person who can choreograph a quick turnaround. The move was music to our ears. Investors didn’t mind, either: shares were trading up nearly 10% in the pre-market following the announcement.
After leading the company for fifteen years, Bob Iger has “agreed” (more like demanded) to come back for another two years, effective immediately. Despite hand-selecting Chapek to succeed him, one could sense the disdain between the two as of late. Under Iger’s tenure, Disney grew from a theme park juggernaut into a media empire, thanks to four astute acquisitions and the launch of the Disney+ streaming service. Now, instead of resuming his acquisition strategy, he will set about mending the fences in Hollywood which Chapek tore down and maximizing the post-pandemic comeback in his parks and resorts.
There are no systemic reasons why Disney cannot stage an impressive comeback with the right leadership. Streaming may be mega-competitive, but that should worry Netflix (NFLX $291) more than Disney, as the former is a one-trick pony. Despite hefty price increases at the parks, we expect visitors to continue flooding back; and with the company’s impressive media franchises (Pixar, Marvel, Lucasfilm, and 21st Century Fox), the content possibilities seem endless. It is simply time for Iger to perform damage control using a tool Chapek didn’t have: charisma.
We have said repeatedly that we would never re-add Disney to any Penn portfolio while Chapek was CEO. Well, now he is gone. Let the comeback begin.
Th, 17 Nov 2022
Personal Finance
As we near a possible recession, Americans hit a new record of household debt
Let’s put some gargantuan numbers in perspective. The annual US GDP, or the total value of all goods produced and services provided within the country, is currently $25.66 trillion—far and away the largest in the world. Sadly, like the talented athlete with a fat new contract but little financial control, the country is currently $31.26 trillion in debt. The next-largest number is reserved for the US consumer, otherwise known as the world’s golden goose. Despite concerns over a coming recession, household debt in the US just rose at its fastest pace since 2007, bringing the figure up to a whopping $16.5 trillion.
Most disturbingly, credit card balances rose more than 15% from last year, the biggest spike in two decades. Despite the Fed funds rate sitting at 4%, the average credit card carries a 20% interest rate, with the average store-branded credit card charging 26.72%. Total debt jumped $351 billion during the July-through-September period alone—the largest quarterly increase since 2007 as well. Interestingly, the 8.3% year-over-year jump in total debt exactly matches August’s inflation read. While the rate of inflation cooled to 7.7% according to October’s CPI report, something tells us the $16.5 trillion figure will not drop.
In fairness, outstanding mortgage balances account for some $11.7 trillion of the aggregate debt, followed by $1.5 trillion in both auto loan and student loan debt, and $1 trillion worth of credit card balances. The remaining amount consists of mortgage originations, or loans taken out against the value of one’s home. Sadly, many of these loans are initiated to pay down credit card debt; balances which have a tendency to build right back up. These are not good data points going into a turbulent economic period.
As interest rates were low and student loan interest was placed on hold, Americans had the perfect opportunity to draw down their personal debt levels. Many did just that, but too many others decided to wantonly spend despite rising prices. And why not? The government has no problem spending money it does not have.
We, 16 Nov 2022
Space Sciences & Exploration
Furthering US dominance in spaceflight, NASA launches Artemis to the moon
Fifty years almost to the month after Gene Cernan and Harrison Schmitt became the last humans to walk on the moon, NASA is ready to send a new generation of Americans to the lunar surface. At 1:47 a.m. EST the largest and most powerful rocket ever launched lifted off from the Kennedy Space Center, sending the Lockheed Martin-built (LMT $468) Orion crew capsule on its 25-day journey around the moon and back. The Space Launch System (SLS)—part of the Artemis Moon program—has been a massive effort involving a number of aerospace companies, to include Lockheed, Boeing (BA $173), Northrop Grumman (NOC $502), Aerojet Rocketdyne (AJRD $50), and Airbus (EADSY $30).
Orion should reach the moon within six days, passing within sixty miles of the lunar surface before settling into its deep retrograde orbit—a looping route that extends 40,000 miles beyond the moon. That will set a record for the furthest distance from the Earth for any crew-capable ship in the history of human spaceflight. After spending two weeks in orbit, the craft will return home on 11 December with a Pacific Ocean splashdown.
Much like the one-person Mercury, two-person Gemini, and three-person Apollo craft, NASA is taking a step-by-step approach with this program. Artemis 1 will show that the craft can safely ferry astronauts back to the moon; Artemis 2 will carry a crew of astronauts to lunar orbit; Artemis 3 will place Americans back on the moon’s surface. It should be noted that Artemis, in Greek mythology, is the twin sister of Apollo. While remaining on schedule with any crewed space program is always extremely challenging, NASA’s plans call for a landing to take place on the lunar surface as soon as 2025.
The Apollo missions completed one of the greatest achievements in human history; in some ways, however, the Artemis program is even more important. Like our ancestral explorers, the earliest journeys always pave the way for trips designed to settle new lands. Between the six-person Orion capsule and Elon Musk’s Starship, which can be configured to carry a crew of up to 100, it is fair to say that we are entering the most exciting phase of our nascent journey into space. NASA has, in fact, already tapped SpaceX and its Starship for the second lunar landing program. We own all of the companies listed in this story other than Boeing. Despite SpaceX being privately held, we own that company via a private equity fund within the Penn Dynamic Growth Strategy.
Mo, 14 Nov 2022
Homebuilding
Lennar is building a 3D-printed community in the suburbs of Austin, Texas
It seems like something out of a science fiction novel, but it is happening in our own backyard right now. America’s second-largest homebuilder, Lennar (LEN $87), in partnership with 3D printing company ICON, is developing a 100-home community near Austin, Texas consisting entirely of 3D-printed homes. The community will offer buyers a selection of eight floorplans and 24 unique elevations ranging from 1,574 to 2,112 square feet of living space. The three to four bedroom, two to three bath homes will be partially powered by rooftop solar panels and come with a price tag starting in the mid-$400,000 range.
The 3D printers creating the homes are nothing short of remarkable. Designed to operate 24 hours per day, they are fully automated with just three workers needed at each home site. The ICON machines build the entire wall system of the house, to include electrical and plumbing, three times faster than traditional methods and at around half the cost. The walls are made of concrete, meaning increased strength and excellent energy efficiency. It takes the massive printer about two weeks to “build” (picture toothpaste coming out of a tube) one home. This is the first 3D housing development project to be completed fully on site, but we expect it to be the start of a revolutionary transformation in the homebuilding industry.
There are many fascinating facets to this story, from the innovative robotics involved, to the possible effect of reducing housing inflation, to the impact on the price of building materials (think of the reduction in lumber use within these sites). Lennar remains on the cutting edge of homebuilding innovation, and is our favorite player in the space.
Sa, 12 Nov 2022
Market Pulse
Week in Review: Markets dropped after the election, soared on inflation data
There were two big potential catalysts for the stock market this past week: the mid-term elections and the CPI report. Following Tuesday’s mixed election results, investors decided it was time to sell; the major benchmarks all dropped in the 2% range. We were worried that Thursday’s CPI report, which gauges the rate of inflation in the US, would provide another excuse to keep the risk-off train moving. Instead, the rate of growth of inflation actually slowed to levels not seen since January, and it was off to the races. While led by the Nasdaq and small-cap Russell 2000, which were up 7.35% and 6.11% on the day, respectively, the S&P 500 and Dow also roared into the close. For the S&P 500 to move 5.54% in any given session is mighty impressive. Instead of taking some profit off the tables on Friday, investors followed up with another nice move higher. Everyone who finally threw the towel in on big tech names like Apple (AAPL), Microsoft (MSFT), and Google (GOOGL) paid a steep price this week: all were up nicely, with the latter two jumping 11.5% on the week. Good news also came with the price of crude, which fell 4% over the five sessions, dropping to an eight-handle. Both the ten-year and two-year Treasury yields fell more than 8% on the week.
Of all the market statistics from this past week, we find the Treasury rate change most interesting. The 2-year tends to predict what the Fed will do next, while the 10-year is more tethered to the 30-year mortgage rate. The plunge in the 2-year Treasury yield, from around 4.7% on Monday to 4.324% on Thursday (the bond market was closed on Veterans Day), signals a smaller rate hike might be in the cards for December’s FOMC meeting—at least in the minds of investors. We shall see—there remains a hawkish tone among the Fed governors.
Fr, 11 Nov 2022
Cryptocurrencies
Once called the JP Morgan of crypto, Sam Bankman-Fried’s wealth evaporates
Sam Bankman-Fried, the wonder boy of the crypto world who built the world’s second-largest crypto exchange, is finished. Were his FTX publicly traded, it would have probably garnered a market cap in the $20 billion ballpark a few weeks ago; now, the company has announced bankruptcy plans and Fried has resigned as CEO. The FTX token, which was selling for $80.50 in September of last year, is now going for $2.77 (down 60% in one day) and is probably worth a lot less than that. The wunderkind who went in front of Congress earlier in the year to explain the 2008 financial crisis—and how his exchange is completely different—was apparently using customer assets to fund ultra-high-risk bets by Alameda Research, a now-defunct quant trading firm majority-owned by Fried. High profile investment entities, from Softbank to Sequoia Capital to the Ontario Teachers’ Pension Plan, will lose virtually all the money they entrusted to FTX. Of course, their investment losses pale in comparison to Bankman-Fried’s personal erosion of wealth, which has dissolved from a high of around $16 billion to well under $1 billion today. But if a loss of wealth is all he suffers in the end, the JP Morgan of crypto should thank his lucky stars.
Highly sophisticated investors—and millions of everyday Joes—were wantonly pumping money into speculative vehicles which weren’t quite as transparent as the likes of Fried led them to believe. This was gambling, not investing. Ironically, Fried was seen as crypto’s white knight, riding to the rescue of “weaker” players. It appears he was doing so with money that didn’t belong to him. If this had to happen (and it did), it is a good thing that it came to light now—crypto had already been so pummeled that the contagion effect is relatively muted. Except, that is, for the investment houses like Softbank, which reportedly will lose some $100 million on the liquidation.
Th, 10 Nov 2022
Supply, Demand, & Prices
Finally! Inflation shows signs of cooling and the market’s reaction is intense
In normal times, a 7.7% year-over-year inflation reading would send the markets reeling. Instead, the latest CPI report led directly to a 1,201-point-gain in the Dow (3.7%), a 208-point-gain in the S&P 500 (5.54%), and an explosive 761-point-gain in the Nasdaq (7.35%). Those remarkable, one-session returns occurred thanks to slowest y/y inflation rate since January. This past June, the 9.1% reading marked the highest rate of inflation in the US in four decades. September’s report wasn’t much better, coming in at 8.2%. Breaking the report down, core CPI—which excludes food and energy—came in at 6.3%, which signaled another slowdown in growth from the previous months. October’s jobs numbers also gave the doves a ray of hope that the current hiking cycle may be on its last legs: the US unemployment rate rose from 3.5% to 3.7%. Wage growth is also easing, going from 5% y/y in September to 4.7% in October. No Fed officials came out and applauded the CPI report, but investors certainly celebrated by giving the market its best day in over two years.
While a 75-bps-hike is still expected at the December FOMC meeting, the odds of a smaller, 50-bps-hike are rising. Were the latter to happen, it would probably spell a serious Santa Claus rally going into the last few weeks of the year.
We, 09 Nov 2022
Media & Entertainment
Disney falls another 11% after dismal earnings report
We wrote a scathing indictment of Disney’s (DIS $88) management team this past spring, stating that CEO Bob Chapek must go. At the time, Disney shares had plunged to $138, down from $203. The latest drop—11% at the open—came in response to another bad earnings report. Revenues were a miss; earnings were a miss; streaming losses widened. While Disney+ added 12.1 million new accounts in the quarter, that business lost a whopping $1.47 billion. Since it launched back in 2019, the streaming service has now lost some $8 billion in aggregate. The parks have been doing great, but that is a huge deficit to keep covering. After spending $30 billion on content over the past twelve months alone, management announced cuts were coming to the content and marketing budgets but gave no specifics. Disney’s bottom-line numbers for the quarter say it all: Against expectations for $788 million in net income, the company made just $162 million. At least they remained in the black.
Analysts have overwhelmingly been bullish on this stock all year, projecting a big comeback in the share price. Considering Chapek just received a three-year contract extension, even $88 per share does not look attractive to us. What was the board thinking?
Th, 03 Nov 2022
Hotels, Resorts, & Cruise Lines
Airbnb is trading in double-digits again; is the stock worth a look?
Despite pricing its initial public offering shares at $68, the typical Joe had to buy Airbnb (ABNB $94) shares on the open market back in December of 2020. For anyone who wanted to jump into this highly touted travel name at the open (like us), the price was steep: shares opened at $146 and remained in triple digits for over a year. Now, investors can get in for the “bargain price” of just $94 per share—36% cheaper than the opening-day price. But are the shares actually cheap?
The company just had its “biggest and most profitable quarter ever,” with revenue of $2.9 billion and adjusted earnings of $1.5 billion. Gross bookings rose 31% in the quarter, beating estimates. Why, then, did ABNB shares plunge nearly 20% this week? It all revolves around guidance. For Q4, management expects revenue in the $1.85 billion range and growth of around 25%, “consistent with historical seasonality.” CEO Brian Chesky said the company is well positioned for the road ahead and has taken steps to reduce costs in preparation for a tougher economic environment. As with Powell’s comments on rate hikes, investors seemed to contort the words to paint a darker view of what’s to come. Hence, the major price drop.
In its “Airbnb 2022 Summer Release,” the company announced a slew of enhancements which would amount to “the biggest change to Airbnb in a decade,” according to Chesky. From an enhanced app experience to new protections for both guests and hosts, these upgrades should keep the company well ahead of its competitors in the space. While they are being attacked from both sides—the online travel agencies (to include Booking and Expedia) and the major hotel chains (primarily Hilton and Marriott)—the $60 billion firm controls approximately one-fifth of the entire vacation rental market. Considering the value of that market is projected to exceed $100 billion within five years, simply maintaining their ratio would spell strong growth ahead for the company. Investors are not in the mood, however, to give any consumer discretionary name a benefit of the doubt right now. Shares have fallen 43% year to date.
With its forward P/E of 32, Airbnb’s valuation remains richer than its online travel competitors and roughly in line with the major hotel chains. While we aren’t ready to add the company to a portfolio, the price seems to be at the upper end of the “fair” range. Should the shares fall closer to the IPO offering price of $68, we would almost certainly jump in.
We, 02 Nov 2022
Interactive Media & Services
Monetizing Twitter: Elon announces a new price plan for Twitter Blue
We were familiar with the blue checkmark symbol next to the name of Twitter users, but we never really gave much thought to who gets one and who does not. Introduced in 2009, this verification system was meant to provide a level of validity to notable account holders, such as celebrities, brands, and organizations. Sort of a caste system on the platform to separate the gentry from the hoi polloi, or unwashed masses. Elon Musk, self-proclaimed Chief Twit, is not a fan of such hierarchies, and he sent out a great tweet indicating what he thought of the policy: “Twitter’s current lords and peasants system for who has or doesn’t have a blue checkmark is bulls***. Power to the people! Blue for $8/month.”
Twitter Blue has been a subscription-based service which allows users to edit tweets, organize them into folders, and access other member-only perks. While Twitter has some 300 million daily active users and generated $5 billion in revenue last year, only around 424,000 accounts hold the coveted blue checkmark. Elon Musk has a grand vision for Twitter, and monetizing the platform is paramount. While the fee would go up to $8 per month, qualified users would be virtually guaranteed of receiving the verification stamp, and we can certainly expect Musk to roll out more perks in the months to come. His ultimate goal is to create what he calls “X, the everything app.” This “super app” would include social media interaction, messaging, payments, and even the ability to order food and drinks. Doubters abound, just as they did with Tesla in the early days, and some companies are indicating they may stop advertising on the platform. They will end up on the wrong side of this story after Musk is done writing it.
This past Friday, we saw a tweet which read: “Twitter hasn’t been this much fun in years.” Despite the naysayers, we fully expect Musk to transform what the platform is today into something quite different—and much more powerful. Some users and advertisers won’t come back, but we doubt the new owner, with his “move fast and break things” mentality, will give them a second’s worth of thought.
Tu, 01 Nov 2022
Transportation Infrastructure
Uber shares spike after the company reports beat on sales, strong ridership growth
A few weeks ago, shares of Penn New Frontier Fund member Uber (UBER $31) fell sharply on news that the Biden administration wanted to force gig economy companies to reclassify drivers as employees rather than freelancers. At the time, we believed that drop was a mistake, as there is very little chance the plan would ever see the light of day. That would have been a good time to get into the ridesharing company. Shares spiked over 15% mid-week as the company reported a staggering 72% jump in sales—to $8.34 billion—from the same quarter in 2021. Gross bookings rose 26%, to $29.1 billion, and adjusted EBITDA came in at $516 million—another beat. Uber Eats, the food-delivery unit of the company, now accounts for one-third of Uber’s total revenue mix.
In addition to the sales beat, Uber CEO Dara Khosrowshahi said he is quite optimistic about the fourth quarter, adding that even lower-income riders are increasing their ridership despite looming recession fears. He projects $600 million in adjusted earnings over the course of the quarter. As for the worker shortage, Uber’s global driver base is now back to pre-pandemic levels.
We have stuck with Uber through the horrendous 2022 downturn because we believe in the company’s growth trajectory. By building out a suite of delivery services, the company has insulated its business (to a good degree) from cyclical economic downturns. Additionally, the industry has a rather wide moat, and Uber is the clear leader in the space. We maintain our $70 price target on the shares.
Headlines for the Month of October, 2022
Sa, 29 Oct 2022
Market Pulse
The foolishness of the mainstream media was on full display this week
Back in July, as the market was rebounding from its June lows, CNBC’s Jim Cramer frantically declared, “The market hit its bottom on June 16th!” Of course, he was proven wrong just a few months later. After the September bloodbath, Jim Cramer told his viewers that he had been talking to a lot of “big investors,” and they were all telling him the S&P 500 would take out 3,000 on the way down, and that the fed funds rate wouldn’t stop until it hit 6%. At the time, the S&P 500 was at 3,657 (we looked at the ticker the minute he made his rant). This was before what is shaping up as the best October in decades.
Yes, big tech got hit this week on weaker-than-expected earnings and some sobering guidance. But let’s take Apple (AAPL $156) as an example of just how reactionary the press really is. The minute the Cupertino-based giant announced a miss on iPhone 14 sales, and that revenue growth could slow during the coming holiday season, AAPL futures dropped some 8%. Immediately, the panel of esteemed hosts on a certain business channel began falling all over themselves to explain why the stock was down, how they saw this coming, and the bad things it portended for Apple as a company. The next day, instead of following through on the 8% drop, Apple shares climbed 8%—a 16% swing from the post-earnings futures. You would think these individuals would stay mum based on their previous afternoon’s comments. No, instead they doubled down on their dumb comments.
We find it highly impressive that, following some rather glum reports and guidance, all the major benchmarks were up this past week—including the Nasdaq (where the tech giants live). While we still haven’t clawed back September’s brutal losses, we are making good progress. This tells us investors believe a couple of things: that the Fed is going to do another 75-basis-point hike next week but then indicate a slowdown of the rate of increases; and that earnings are not coming in nearly as bad as feared, despite the FAANG disappointments. We believe they are correct on both counts. Too late to go back and declare another market bottom in September, Cramer, that ship has sailed.
We believe we are in the early stages of a Santa Claus rally, buttressed by a Fed slowing its pace and by the mid-term elections. Who will lead the charge? Probably the small caps, which have been severely beaten down and are spring-loaded for a comeback.
Fr, 28 Oct 2022
Aerospace & Defense
Boeing, led by its inept management team, fumbled yet another quarter away
The once-great American aerospace giant Boeing (BA $135), led by bumbling CEO Dave Calhoun, has announced yet another lousy quarter. Against expectations for $17.8 billion in sales, the company brought in just $16 billion; from that $16 billion, the company managed to lose $3.275 billion along the way. Put another way, the Street was expecting earnings per share of $0.10, instead it delivered a $5.49 per share loss.
While the bottom-line net income still would have been negative, the enormous loss was overwhelmingly a result of a $2.76 billion hit the company took on the aggregate of five fixed-price development programs, to include the (nightmarish) KC-46 tanker program and the (long delayed) Commercial Crew program. The KC-46 USAF tanker program alone accounted for a $1.17 billion loss. Are you ready for the “leader’s” response? CEO Dave Calhoun said the charges were driven by macroeconomic forces beyond Boing’s control. Way to take ownership, Dave.
The concept of the learning curve with respect to huge companies building complex systems states that costs go down with the repetition of a smooth-running assembly line. Calhoun said, “We don’t have any baked-in learning curves anymore.” True, you obviously don’t. What you didn’t say was that it is all management’s fault. It is hard to BS your way through the publicly traded landscape: Boeing has lost 70% of its value since 01 March 2019. How about an apples-to-apples comparison: Boeing’s disastrous finances are reflected in its -3.25 debt/equity ratio; Airbus (EADSY $26) has a debt/equity ratio of 1.32. We suppose the “macroeconomic environment” is rosier in Europe?
There is a fiefdom at Boeing, with Calhoun having anointed himself king and the jesters on the board facing little pushback from the poor citizens (shareholders). Until the autocratic regime is overthrown, there is no reason to own shares of this once-great company.
We, 26 Oct 2022
Interactive Media & Services
Snap continues to disappoint the Street; is the stock now cheap enough to buy?
It is becoming a quarterly ritual: Snap (SNAP $10) reports earnings, and we report the company’s double-digit share price drop. It just happened again. Last Thursday, for the third consecutive quarter, Snap missed on both revenues and net income, generating $1.128 billion in sales and losing $359.5 million in the process. Management then proceeded to give an outlook so lousy that the company’s shares gapped down some 28% on the day. While they have climbed back a bit from their new 52-week low of $7.33, investors shouldn’t be too eager to jump in at these “bargain basement” prices (shares remain down 80% for the year).
Snap has an impressive base of 158 million daily active users, but the company generates nearly all its revenue from advertising; and 88% of those ad dollars emanate from US companies. After surprisingly bad numbers from much larger competitor Alphabet (GOOG $105), particularly in its Snap-like YouTube unit, expect a rough year ahead as the US muddles through a recession. Digital ad spends are among the easiest cuts made by corporations as they hunker down in preparation for an economic downturn, and Snap would be an easier advertising cut to justify as opposed to a pullback in online ads at Google, for example. In short, we fail to see any near-term catalysts that would drive the shares substantially higher from here.
We have discussed the comically skewed share class structure (in favor of management) at Snap, so no reason to rehash it now. Suffice to say investors looking for deals among the tech carnage can find better opportunities elsewhere.
Mo, 24 Oct 2022
Global Strategy: Europe
Labour will have a much tougher time trying to discredit the new UK prime minister
Including the one just selected, there have been eight prime ministers of the United Kingdom since Maggie Thatcher left that post in 1990; seven have been Tories (Conservative Party), and one has been a member of Labour. The newest resident of 10 Downing Street, Rishi Sunak, has made it clear who he most idolizes: Margaret Thatcher.
On its face, the optics of having been through four Conservative Party PMs within the last three years and three within the past seven weeks should bode well for Labour going into the next general election, which must be held no later than early 2025 (the last, held in December of 2019, was a landslide victory for the Tories). But Rishi Sunak is no Theresa May, nor is he a Liz Truss; the left will be in for a bit of a surprise as they feign insult at every turn and begin their interminable attacks.
At age 42, Sunak will be the youngest prime minister since William Pitt the Younger assumed office—at age 24—in 1783. Indian by heritage, Sunak’s mother was a pharmacist and his father was a general practitioner in the National Health Service. After graduating from Oxford, he received his MBA from Stanford while living in the United States. Although he was Boris Johnson’s chancellor of the Exchequer (think Treasury secretary), he resigned this past summer after questioning his boss’ ethics. He has experience in the world of investment banking, working at Goldman Sachs and as a hedge fund manager in the US.
Following in his idol’s footsteps, Sunak believes in lower taxes and controlled government spending; though he did oversee the massive furlough program which made payments to the millions of Britons who lost their jobs during the pandemic. He enters office at a critical period, as economic conditions in Great Britain continue to deteriorate. Facing the twin culprits of weak economic growth and rampant inflation (stagflation), his honeymoon period will be short. However, his real-world experience in finance should serve him well, despite the loud and obnoxious voices of his critics.
Rishi Sunak may never breathe the rarefied air of the Iron Lady, but we expect him to be a highly effective PM—to the chagrin of his haters. We will also make the bold prediction that he will still be in power for the next general election, which he will proceed to win. For investors wishing to take advantage of an economic rebound in the UK, look at EWU, the iShares MSCI United Kingdom ETF. One of its top holdings—Diageo PLC (DEO $165)—is an inaugural member of the new Penn International Investor fund.
We, 19 Oct 2022
Commercial Banks
Credit Suisse looks a lot like Lehman in 2008; could the global bank really fail?
Credit Suisse Group AG (CS $5), founded in 1856, is one of the two major Swiss banks and an important player in global finance; the Zurich-based firm maintains offices in all major financial centers around the world. Going into the 2008 global financial crisis, the bank had a market cap of $90 billion; today, it is a shell of its former self, boasting a market cap of just $12 billion. While it survived the global banking crisis, recent scandals have driven investors away and have some analysts handicapping a nightmare scenario: insolvency.
The recent scandals began when British financial services firm Greensill Capital, in which Credit Suisse had some $10 billion invested, went belly up, causing CS clients to lose around $3 billion. Then came the Archegos Capital (Bill Hwang) debacle. While the privately held company primarily managed the assets of family office group trader Hwang, CS was a major lender to the firm. As Archegos was imploding and before Hwang was arrested for securities and wire fraud, the company lost $20 billion in a matter of days. Credit Suisse itself was out $4.7 billion, causing a half-dozen executives at the bank to lose their jobs. In February of this year, the bank was charged with money laundering (it was later found guilty by a Swiss court) in connection with a Bulgarian drug ring. Shortly after that, details of approximately 30,000 customer accounts at the bank—worth over 100 billion Swiss francs in aggregate—were leaked to a German newspaper. The leaks exposed customers involved in all types of lurid behavior, from human trafficking to torture. Finally, and most recently, it was discovered that executives at the bank urged certain investor-customers to destroy documents linked to Russian oligarchs who had been sanctioned following the invasion of Ukraine.
This past summer, Credit Suisse Chairman Axel Lehmann replaced the bank’s CEO with its head of asset management, Ulrich Koerner, and announced a strategic review of its investment banking unit. The bank’s upcoming earnings release—slated for 27 October—is expected to show a reduction in the bleeding from Q2, but that will not be enough to quell investors. A comprehensive restructuring plan is needed, but we doubt the current management hierarchy is up for the job. That said, we don’t believe the bank faces any real threat of insolvency—it is “too big to fail.”
There has been some intriguing speculation recently that the other major Swiss bank, UBS (UBS $15), with its $52 billion market cap, could swoop in and save Credit Suisse via a merger. While we don’t see that scenario playing out (Swiss regulators would not be keen on the idea), a positive upside surprise on the 27th could move the shares higher. Analysts run the spectrum of expectations, from CFRA’s $3.50 price target to Morningstar’s $10.60 fair value. While it may be fair to say the company is not going the way of Lehman, the risk of it languishing while management tries to clean up its mess is too great to justify an investment—even at $4.58 per share.
Tu, 18 Oct 2022
Social Security, Medicare, & Medicaid
Social Security recipients will receive their largest increase in four decades next year
In the face of soaring inflation, the Social Security Administration has announced that beneficiaries will receive an 8.7% cost of living increase in 2023—the largest adjustment since 1981’s 11.2% bump. This move comes on the heels of a 5.9% upward adjustment in 2022. On average, next year’s rate increase will amount to $146 more per month in recipients’ bank accounts. Additionally, Medicare Part B premiums, which are generally deducted from Social Security benefit payments, will be lowered next year from $170.10 to $164.90. Approximately 50 million Americans receive Social Security each month, with another ten million receiving disability payments and six million receiving survivor payments. The average payment for retired workers in 2022 is $1,670, while survivors average $1,328 per month. Per Social Security Administration figures, total income collected for the Social Security Trust Fund last year was $1.088 trillion, with $1.145 trillion going out in the form of payments—a $56 billion deficit. At the end of last year, the Fund had $2.852 trillion in asset reserves.
In early 1968, President Lyndon Baines Johnson moved the Social Security Trust Fund “on-budget,” meaning it would be considered part of the unified budget of the United States. In 1990, under President George H.W. Bush, this action was reversed, moving the Fund back “off-budget.” To see income, outflow, and reserve levels of the Fund, readers can visit the Social Security Administration website.
Tu, 11 Oct 2022
Government Watchdog
The rotten law that California voters rejected is about to be shoved down America’s throat
Think of how the likes of Uber (UBER $25) and Lyft (LYFT $12) have radically transformed—for the better—transportation in this country. Bargoers who wouldn’t have considered calling for a Yellow Taxi at two in the morning routinely hail rides on their app. Elderly shoppers in suburban regions can now get a convenient and reasonably priced ride to and from the grocery store. Apparently, that is a transformation which must not be allowed to stand.
The subversive movement to halt this positive trend began, fittingly, in California. Assembly Bill 5 (AB5) said that all workers, to include drivers for ride-hailing services, had to be considered employees of the company rather than freelance “gig” workers. Never mind the fact that most of these drivers did not wish to be considered employees. Then came Proposition 22, passed by a majority of California voters, which exempted these workers from being classified as employees rather than independent contractors. Understandably, Prop 22 was a major win for the industry.
Since such an important issue cannot be left to the masses to decide, the results immediately came under fire. A California judge ruled the measure unconstitutional. The battle rages on, but now the White House has chosen to take a stand on the issue. President Joe Biden has ordered his Department of Labor to review how workers are classified. In short, the administration wishes to codify, on a national level, California’s AB5. As this move would cause operating costs in the industry to skyrocket, shares of Uber and Lyft plunged on the news. Other companies in industries from trucking to construction also dropped on the DOL proposal. An attorney for the department said the move was “not intended to target any particular industry or business model.” Is anyone dense enough to believe that?
As we are on the precipice of a recession, what an incredibly thickheaded time to go forward with such anti-business nonsense. There will be an endless stream of legal challenges to the coming decree, and we expect the final decision to be made by the US Supreme Court. In the meantime, we have yet another roadblock in the way of getting our economy back on track.
Tu, 11 Oct 2022
Automotive
It has been a rough road for Rivian since its IPO, and that was before the massive recall
Talk about lousy timing. Last November, one year ago next month, signaled the peak in the stock market, and it has been a bumpy downhill slog from there. Last November was also when EV maker Rivian (RIVN $31) presented itself to the investment world via an IPO. Initially priced at $78, shares quickly soared to $179.47 on 16 November, just six days after the IPO. Woe to any investor who jumped in then: the current stock price represents an 83% drop from that all-time high.
In a tough economic environment, marred by supply chain issues and rising input costs, Rivian has been consistently missing its own production targets; now, on top of that, the company is being forced to recall nearly all its vehicles on the road for steering control issues. While there have been no reported injuries and the fix is relatively straightforward, the problem will divert precious resources away from production at a time when the startup is already under intense scrutiny for over-promising and under-delivering.
The first Rivian rolled off the assembly line in September of 2021, and the company has produced just 15,000 vehicles to date. The 2022 full-year production target is 25,000 vehicles, which is all but guaranteed to be another miss. Rivian has a market cap of $28 billion, down from a November high of $153 billion. The company's R1S electric pickup has a price range between $72,500 and $90,000, while the longer-range R1T, fully loaded, will set a buyer back around $100,000.
For those who believe Rivian is the next Tesla, $31 per share may seem like a great point at which to buy the stock. While the company has enough cash on hand to weather the production and recall problems, the potential for further price erosion is too great to justify an investment right now. For those willing to take the risk in the automotive industry, Ford (F $11) looks a lot more attractive with its 5.668 forward multiple.
Sa, 08 Oct 2022
Market Pulse
It was a positive week in the markets, so why didn’t it feel that way?
The week began with the best two-day rally since April of 2020, with the S&P jumping some 5.6%. A few signs arose which gave the market hope that inflation was starting to be tamed, which might lead to the end of rate hikes. Wednesday was flat, Thursday investors began to worry, and Friday’s strong jobs report capped the U-turn. The unemployment rate fell from 3.7% to 3.5%, the labor force participation rate remained steady at 62.3% (we need more workers rejoining the labor force), and 263,000 new jobs were created—more than anticipated. We are back to the bizarre world where good news is bad news. This all but assured more rate hikes, with odds strong for a 75-basis-point hike in November, followed by a 50- and then 25-bps hike in December and January, respectively. That would put the upper limit of the fed funds rate at 4.75%, at which time Powell and company should be able to put the tightening on hold.
That probable scenario spooked the Dow into a 630-point selloff on Friday, which is absolute silliness. A 4.75% rate is not economy crushing, as we have weathered much higher rates in the past. The average 30-year mortgage loan now comes with a 7% APR, which has certainly dissuaded homebuyers and seized up the refinance business; but runaway home values are beginning to level out—an important component to controlling inflation. Another big weight on the markets this week came courtesy of OPEC, which promised to curb oil production by two million barrels per day. The cartel’s aim is to stick it to Biden while getting oil prices closer to triple digits, and it seems to be working: the price for a barrel of crude rose from $79.74 before Monday’s open to $93.20 by Friday’s close.
By the end of the week the Dow had actually pulled off a 1.99% gain, followed by the S&P 500 at +1.5% and the NASDAQ at +0.72%. Market emotions were on full display over the five-session period, going from hopeful anticipation on Monday to depressed capitulation on Friday. It may seem odd, but these kinds of wild swings are often the precursor of something good waiting around the corner.
It has been a painful year, but we are now in the bottoming-out process. When the market senses that the Fed is near the end of tightening, there will be a rally akin to the one we experienced during the vaccine phase of the pandemic. Barring, of course, a cornered Russian thug doing something even more horrific than he already has.
Th, 06 Oct 2022
Beverages, Tobacco, & Cannabis
Cannabis stocks rocket after Biden requests drug classification changes
It was one of the moves North American cannabis producers have been anxiously awaiting: President Biden has formally requested a review of how marijuana is classified under US law. He further requested that governors move to pardon anyone in a state prison solely for marijuana possession (there are fewer than 10,000 incarcerated in federal prisons under these circumstances). Despite wild success in Canada and much of the rest of the world, leading producers such as Tilray (TLRY $4), Curaleaf Holdings (CURLF $6), and Canopy Growth (CGC $4) have been waiting for the mother lode of being able to freely sell their products in the richest market in the world. That dream is coming closer to fruition. While it will still be a largely states’-rights issue, a change in federal law would allow cannabis companies to access full banking services and list on US exchanges.
How did the publicly traded cannabis companies respond to the news? Our favorite, Tilray, run by the highly skilled Irwin Simon (founder of Celestial Seasonings), popped 31% in one session; the AdvisorShares Pure US Cannabis ETF (MSOS $12) surpassed even that performance, jumping 35% on the day. Granted, there is a long way to go before our laws on marijuana resemble those of our neighbor to the north, but investors should also keep in mind that this group has been absolutely hammered over the past year. The cannabis ETF, for example, is still down 65% year to date despite the enormous untapped potential of an open US market.
We mentioned Tilray, which is actually the result of a merger between the namesake company and Aphria. Not only did Simon oversee the purchase of SweetWater Brewing Company, he also spearheaded the purchase of Breckenridge Distillery, maker of the high-end line of Breckenridge bourbon whiskeys. We see cannabis-infused booze coming in the not-to-distant future.
Th, 06 Oct 2022
Energy Commodities
OPEC’s win-win solution: take a jab at Biden and get a spike in oil prices
To say there is no love lost between the Biden administration and the Kingdom of Saudi Arabia is quite an understatement. When Biden flew to Saudi Arabia this past summer in an effort to get the titular head of OPEC to raise production, the country responded with a slap-in-the-face promise to boost output by a paltry 100,000 barrels per day. Now that the administration is getting what it wants before the upcoming mid-term elections—lower prices at the pump—OPEC+ holds a meeting in which it announces a two million BPD production cut. Oil futures, which had dropped to the upper-$70s/bbl range recently, surged back into the upper-$80s. This was a win for not only Russia, which has navigated the oil ban by selling crude to its nation-state buddies China and India, but also for Saudi Arabia, which got another chance to poke Biden in the eye and get the price of oil closer to its target $100/bbl range.
The administration, clearly miffed, is responding in the feeblest of ways: promising to tap the US Strategic Petroleum Reserve yet again and discussing the possibility of easing sanctions on Maduro’s Venezuela. That is akin to a sweater-clad Jimmy Carter holding a fireside chat and encouraging Americans to turn down their thermostats in winter. The administration seems unwilling to take the correct course of action, which is to encourage—in deeds not words—increased production at home.
The two million BPD cut by OPEC will probably only amount to an increase of one million barrels, as many members of the oil cartel are not currently meeting their quota; that amount could be countered were the US to begin pumping the same amount it did back in early 2020. But the love affair between the US energy complex and the Biden administration is on par with the Kingdom’s affection for the president. Additionally, with the litany of recent regulations thrown against “big oil” and the cancellation of the Keystone pipeline, getting back to 13 million BPD would be extremely challenging in the short run. That leaves the greatest “hope” for reduced prices at the pump being a global economic slowdown—something nobody wants. With respect to energy prices, the US finds itself between a rock and a hard place, and American consumers will be the ones getting crushed.
The path of least resistance with respect to reining in oil prices seems to be a global economic slowdown. The regulations which have hampered oil production in this country will remain largely intact, and getting Venezuela back up to speed would take years. Also, consider the fact that there have been no new refineries built within the US for three decades, and the ongoing ESG battle against companies in the fossil fuels industry. That being said, if there is a marked slowdown in global growth we could see oil dropping back into the mid-$70s range this winter.
Tu, 04 Oct 2022
Interactive Media & Services
Twitter pops after Elon says he will buy the company under original terms
There have been a lot of crazy twists and turns in the Musk/Twitter (TWTR $52) saga, but we didn’t see this one coming. In a surprise move, Musk has said he will buy the social media platform under the original terms agreed upon: $54.20 per share, or $44 billion. Odds were stacked against him in the pending non-jury trial, slated to begin later this month, but it is rather strange that he did not come in with a lower offer. While it may not have been enough of a “smoking gun” to get him out of an ultimate deal, his argument that the company was hiding the enormity of the spam bots and fake accounts problem was substantiated by Twitter’s fired head of security—Musk’s key witness. While Twitter shares spiked 13% on the news and 20% in the ensuing days, the market cap still sits about $5 billion below the offer price. The press is making it sound as though Tesla (TSLA $242) shareholders hated the deal, but shares of the EV maker fell very little after the bombshell announcement. In the next issue of the Penn Wealth Report, we will delve into what Musk hopes to accomplish with his new platform. Hint: think indispensable “super app.”
We believe Musk can create a turnaround story at Twitter, a company which was never effectively monetized by erratic found Jack Dorsey and his hand-picked successor, Parag Agrawal. Of course, that will all take place (post deal) with Twitter as a privately held company. As for publicly traded Tesla, shares look like a steal at $242, and we maintain our $333 price target. We own Tesla in the Penn New Frontier Fund.
Th, 29 Sep 2022
Biotechnology
Biogen was down 18% year to date, then some good news sent shares soaring 40%
We are having a serious case of déjà vu with respect to $40 billion biotech firm Biogen (BIIB $277). Last summer, shares of the firm spiked some 55% on the back of positive news regarding its experimental Alzheimer’s drug, aducanumab. In the ensuing year, shares plunged 50%—from over $400 to under $200—on doubts about the therapy’s efficacy, despite FDA approval. This week it was a new Alzheimer’s drug from the firm, lecanemab, which moved shares of the firm back up some 40% in one session. Lecanemab, which was co-developed with Japanese biotech firm Eisai (ESALY $58), slowed cognitive decline in early-stage sufferers who were enrolled in the companies’ Phase 3 Clarity trials. Unlike the prior drug’s trials, which brought a good dose of skepticism from critics, these most recent results were universally hailed by the medical community. With the drug’s potential blockbuster status over the coming years, analysts were quick to upgrade shares of Biogen, though price targets remained relatively close to the day’s trading range. Among the 32 major houses covering the stock, 18 have Outperform or Buy ratings, while the other 14 have a Hold rating. The median price target on the shares is now $267.
Advances in the field of Alzheimer’s have been few and far between for the past two decades. Lecanemab holds a lot of promise, though we must now wait and see what type of support, via Medicare and insurance coverage, it will receive. We do believe, however, that the drug has the potential to generate over $1 billion in annual sales for Biogen.
We, 28 Sep 2022
Capital Markets
2021 was a banner year for IPOs, but most are not faring so well
There were some 400 companies that went public last year via the traditional route, with capital raised coming close to $300 billion. Add SPACs (special purpose acquisition companies) to the mix, and the number hits 1,000 new listings. So, how have these newly-publicly-traded entities been doing lately? The answer isn’t pretty. The Renaissance IPO Index is a basket of the largest, most liquid, newly-listed US public companies. Names like Snowflake (SNOW), Rivian (RIVN), Roblox (RBLX), and Coinbase Global (COIN) top the list. This index has an exchange traded fund, the Renaissance IPO ETF (IPO $29), which allows investors to buy into this basket with ease. Year to date, the fund’s value has been slashed in half, with the shares dropping from $60 to $30 in price. That represents more than twice the S&P 500’s plunge over the same time period. Here’s another staggering statistic: only about one in ten of the class of 2021 are trading above their IPO price. Market volatility due to inflation, rate hikes, supply chain issues, and fear of recession has pounded this group and dissuaded a lot of would-be players from going public this year. According to StockAnalysis.com, only 159 companies have gone public on US exchanges so far this year, or 79% less than the 767 IPOs which had taken place by the same time in 2021. As could be expected, this group has faced a similar fate. For anyone interested in scanning the list for possible value plays, the companies and their “since-IPO” returns are listed on the page.
What about getting into the IPO ETF with the fund sitting down at $30 per share? We wouldn’t recommend it—there are too many wildcards on the list. Some holdings do look promising going forward, however. Names like Palantir (PLTR), Snowflake (SNOW), Airbnb (ABNB), and DoorDash (DASH) have all seen their share prices pummeled, and these are companies which will still be around when the markets regain lost ground.
Tu, 27 Sep 2022
Food Products
Bucking the trend: Penn member General Mills has rallied 20% this year
Virtually all asset classes, sectors, and industries are in the red this year with the exception of energy stocks, and even they have been tumbling recently as crude oil has dropped back to where it began the year—the mid-$70s-per-barrel range. One consumer defensive name has been bucking the trend, however: General Mills (GIS $79) has rallied 20% so far in 2022—hitting an all-time high price last Thursday—and is up some 34% over the past year. Not only did the century-old food products firm report higher-than-expected profits over the past quarter, management also lifted its forecast for the year. Sales in the fiscal first quarter, which ended 28 August, rose 4% (to $4.72B), while net income jumped 31% from the same period last year—to $820 million.
While inflation has raised input and shipping costs for General Mills, the company has been able to pass along some of those higher prices to a consumer which is suddenly eating out less and cooking more meals at home. The stellar management team, led by 55-year-old Jeff Harmening, has also been making some astute strategic moves recently. In an effort to focus on more profitable units, the company recently sold its “Helper” line and Suddenly Salad packaged food division for $607 million, while acquiring St. Louis-based TNT Crust for $253 million. While consumers have been shifting away from higher-priced labels in favor of generic brands, General Mills products remain in the sweet spot. Harmening’s team also placed some well-timed hedge positions on grain inputs, cushioning the blow of rising agriculture prices. For the fiscal year, the company expects to grow net sales by 6-7%.
One of our favorite moves General Mills made a few years ago was the purchase of the rapidly growing Blue Buffalo line of pet foods. In fact, that was a catalyst for our purchase of GIS shares back in 2018. The company is the only packaged food name within the Penn Global Leaders Club.
Fr, 23 Sep 2022
Market Pulse
Another bruiser: markets have now given up two full years of gains
For the past two weeks in particular, the markets have had a myopic fixation on what the Fed’s next moves will be. The Tuesday before last, the Dow Jones Industrial Average lost 1,276 points after a hot August inflation read all but guaranteed a three-quarter-point rate hike in September. This Wednesday, when the Fed delivered, it dropped another 522 points. With the NASDAQ and Russell (small caps) leading the retreat, the major indexes all dropped around 10% over the past ten trading sessions, falling back to October of 2020 levels. So much for the June lows—those were taken out Friday intraday before bouncing slightly. It wasn’t only the Fed, though that was the big catalyst. The other concern markets seem to be stewing about is the strong US dollar, which is at its highest level in precisely two decades. That makes imports and overseas travel cheaper for Americans, but our exports more expensive for the world. But the strong dollar shouldn’t affect US small-cap companies much, as most rely on the domestic marketplace for the lion’s share of their revenues. It has been a brutal year thus far, but if our economy cannot handle a dollar at parity with the euro and a potential 5% federal funds rate, then that is a sad testament to American exceptionalism.
In reality, the US economy can and will be able to deal with these two conditions—a strong dollar and higher rates; it is investors who seem unable to come to terms with the situation. Great American companies, flush with cash and on strong growth trajectories, have not been spared during this latest selloff, which makes little sense. Until the madness abates, we are taking advantage of the dislocation in short-term rates by buying Treasuries, agencies, and quality corporate bonds.
Fr, 23 Sep 2022
Transportation Infrastructure
FedEx shares just suffered their worst day ever; are they now worth looking at?
When FedEx (FDX $148) shares were trading at $245.63 this past February, we removed the company from the Penn Global Leaders Club to make room for another holding. We had lost a good degree of confidence in the management team, and labor costs were suddenly becoming a major drag on the firm. That move was fortuitous, as FedEx just experienced its worst day as a publicly traded company—losing nearly one-quarter of its market cap—after a disastrous earnings call. After giving a rosy outlook in June, management did a 180-degree turn in September, reducing guidance by 50% and predicting a bruising global recession. Analysts were quick to point out that the major issues were not macro in nature, but directly related to this integrated freight and logistics giant. Q1 earnings per share fell 21% from the year prior, against expectations for an 18% gain; revenues rose 5%, but that number missed estimates as well. The company pulled its 2023 guidance altogether, citing a gloomy and uncertain global outlook. To round out the ugly report, FedEx said it plans to raise shipping rates this coming January by an average of 6.9% across the board. Shares are now down over 42% year to date.
With shares trading where they were back in June of 2020, are they now a buy? While the $2.7 billion in cost-cutting measures will help, and customers will probably just accept the shipping rate hikes, we don’t see the shares worth much more than $200 right now; and the risk to get that possible 33% return is still too high in our opinion.
Fr, 23 Sep 2022
Monetary Policy
Powell’s words left little doubt: rate hikes until inflation is under control
For anyone who still believes the stock market is rational and efficient, consider this: Going into the Fed’s rate decision, the Dow was trading up a few hundred points; within seconds of the fully-expected 75-basis-point rate hike, the Dow was down a few hundred points; during Powell’s post-decision speech, the Dow rallied into the green by several hundred points, only to close the session down 522 points.
No matter how late investors or pundits may believe Powell was to the party, his message has been crystal clear: Rates will go up until inflation is brought down to acceptable levels. While the official “acceptable” level is 2%, he said something very telling in his news conference: “The ultimate goal is to have positive real rates across the yield curve.” To us, that was meaningful. By “real rates” he means inflation adjusted, so if the 2-year Treasury is yielding 4% then inflation must be below that. They say markets don’t like uncertainty; well, we now have full clarity with respect to what the Fed plans on doing next.
Of course, we still don’t know how many rate hikes and other shocks to the system it will take to tame inflation. Furthermore, it will take time for the hikes to have their full effect on economic conditions as Fed actions typically have a lot of lag. The central bank forecasts a funds rate of 4.4% by the end of the year, which would point to one more 75-bps hike in November (there is no October meeting) plus a 50-bps hike in December. From there, we may see a few quarter-point hikes before the Fed pauses. We thought it would take a lot to get the fed funds rate to 4%; odds are now in favor of a 5% terminal point. That’s high, but not disastrous for the economy. For historical perspective, we were sitting at a 6.5% rate in August of 2000 and a 5.25% rate in May of 2008. Despite the market tantrums, the economy will weather these rates just fine.
A combination of two catalysts will fuel the coming market rally: signs that inflation is finally coming down, and the Fed’s indication that a pause in hikes is near. We see both of these indicators appearing within the next four months. In the meantime, own quality equities and load up on fat-yielding, shorter-maturity bonds.
Mo, 19 Sep 2022
Fixed Income Desk
The sudden and unusual opportunity in short-term bonds
Every now and again, bizarre things happen in the bond market which provide unique opportunities for investors. When we buy fixed income vehicles, from CDs to Treasuries to corporate bonds, we expect to get a higher yield for taking on the risk of going further out on the time horizon—assuming parity with respect to issuer safety, of course. For example, we expect a 30-year Treasury bond to have a higher yield than a 10-year Treasury note, and that 10-year should be paying more than a 2-year issue. The benchmark spread is the difference between the 10-year and 2-year yield. When the shorter maturity issue has a higher yield than its longer-maturity counterpart, we get a condition known as a yield curve inversion—generally a sign that a recession is on the way.
Right now, we have a quite rare situation: the 2-year Treasury carries a yield higher than all of the longer-maturity issues. Since the 2-year is considered a proxy for what the Fed will do next and the 30-year gauges investor sentiment about the economy, all bets are now on rates continuing to rise until the Fed hits a wall and is forced to pivot. Considering money markets are still yielding close to nothing, and bond values have been dropping in investors’ portfolios, now is a golden opportunity to pick up higher-yielding bonds with shorter maturities and low duration (duration measures sensitivity to changes in the interest rate).
And this opportunity is not limited to government-issued securities. While the 2-year Treasury is currently yielding just shy of 4%, corporate issuers are forced to offer even higher rates (either through new issues or thanks to discounted prices on current bonds in the secondary market) to compete with the risk-free nature of vehicles backed by the full faith and credit of the US government. It has been hard to get excited about bonds for some time; right now, at least with respect to the lower end of the ladder, that is not the case. Investors should strike before conditions change.
We are loading up on low-duration bonds issued by quality companies to take advantage of current conditions. Even bank-issued CDs with maturities of two years are offering rates around 4%. Due to the unique challenges facing Europe and Asia right now, we are sticking primarily to debt issued by domestic firms and financial institutions.
Tu, 13 Sep 2022
Government Watchdog
California dreaming: burger flippers could soon have a $22 per hour minimum wage
On Labor Day, fittingly, California Governor Gavin Newsom signed a stunningly egregious law into effect. While its official name is the Fast Food Accountability and Standards Recovery Act, that is about as accurate as calling a trillion dollar spending bill an Inflation Reduction Act. We have a more accurate name we would like to propose: The $22 Per Hour Minimum Wage Act for Burger Flippers. There are no cutesy acronyms politicians are so fond of, but it clearly spells out the intent.
The law will create a Fast Food Council in Cali, made up of a 10-person cabal of workers, state officials, and management—the latter to make it look credible. This cabal will set the “living wage” for fast-food workers employed at companies which operate at least 100 locations around the country (not the state). Clearly, the target is McDonald’s, Chick-fil-A (the one they really hate), Burger King, Chipotle, and a number of other “fat cats.” The ruling council will have the power to create a new $22 per hour minimum wage for all fast-food workers, beginning next year. The law was strongly supported by the Service Employees International Union, which has been advocating a nationwide, $15 per hour minimum wage. Since California is already set to raise the minimum wage to $15.50 per hour in 2023, we suppose $22 would be the next common sense target.
Of course, there is nothing common sense about this act or the politburo-like body it has created. Two unintended consequences immediately come to mind: $15 hamburgers and a more automated workforce. One will punish consumers who are already reeling from runaway inflation, and the other will punish the very workers who are supposed to be helped by this act. From California, which had attempted to place a cancer warning on every of coffee sold, this move is par for the course. We just can’t understand why so many companies are heading for the exits.
The brilliance of our Founding Fathers in giving so much power to the states (rather than a central government) is once again on full display. Newsom can deny the fact that companies are fleeing his hammer and sickle mentality, and the Chicago mayor can proclaim that the city’s economy has never been stronger, but the evidence proves otherwise. Maybe the voters who keep them in power will see the light one of these days. But we doubt it.
Tu, 13 Sep 2022
Economics: Supply, Demand, & Prices
A hot August CPI report gives the Fed the green light for another 75-bps hike
The seemingly major contingent of investors who believe the Fed is on the cusp of pivoting—moving from rate hikes to a pause to potential rate cuts due to an economic slowdown—befuddles us. In what realm are they living? What metrics possibly back up such a pivot? It is nonsense. With this contingent in mind, it really shouldn’t come as a surprise that Dow futures swung some 700 points, from up over 200 to down over 500, on the back of a higher-than-expected August inflation report. The consumer price index, or CPI, which tracks the price of a large basket of goods and services, rose 8.3% from last year—despite the sharp decline in gas prices for the month. Food, shelter, and medical care costs drove the spike in prices, while the average price for a gallon of gas fell 10.6%. A couple examples of food inflation: eggs are up 40% from last year, while bread is up over 16%. In the auto space, the average price of a new vehicle rose by 0.8% for the month, or 10% annualized. Medical care costs have risen 5.6% from the same period last year. The two-year Treasury note, a proxy for what the Fed might do next, surged from 3.358% to 3.704%, driving bond values down. We have been expecting the Fed to raise rates by 75 basis points at this month’s FOMC meeting; this report all but guarantees that taking place.
The August CPI report and subsequent market drop created a great opportunity for investors. The responsible behavior of the Fed will ultimately lead to a reduction in the rate of inflation, a healthier economy, and a stronger stock market. And it won’t take long for that theory to play out. The closer the Fed gets to 4%, the closer a major rally is to manifesting.
Mo, 12 Sep 2022
Economics: Housing
Mortgage rates hit highest level since 2008
This past week, the average interest rate for a 30-year mortgage did something it hasn’t done since November of 2008: hit the 6% mark. Considering rates topped out about three times that level back in the 1980s, the current rate may not seem too daunting, but that figure reflects a 130% spike from just over two years ago. As the Fed works to get inflation under control, this is certainly one of the intended consequences of the tightening cycle. As mortgage rates rise, it should cool the housing market and, hence, runaway home prices. Unfortunately for would-be buyers, that has not happened, leaving them at the mercy of higher rates and higher prices. For those putting their homebuying plans on hold, there is another problem: rents are rising just as fast. We did a double take when we saw this figure, but the national average for renting a single-family home in the US rose 13.4% from 2021 to 2022, to $2,495 per month. For apartment dwellers the picture is nearly as bad: the monthly rent for a multifamily dwelling in the US rose 12.6% from July of 2021 to this past July, to $1,717. And occupancy rates remain high for rental housing, hovering around 96%. It may seem warped, but this is precisely why the Fed must continue to raise rates. Ultimately, something must put downward pressure on home prices.
It may seem counterintuitive to look at buying the homebuilders now, but their prices have been so beaten down by the fear of rate hikes and a coming recession that they are beginning to look very attractive. While the builders of lower-end homes will face more difficulty, names like Toll Brothers (TOLL $45) and D.R. Horton (DHI $74, Emerald Homes is its luxury division) look attractive. Both companies have ultra-low P/E ratios—both current and forward—in the 4-6 range, and both have plenty of cash on hand to weather any coming housing storm.
Th, 08 Sep 2022
Global Strategy: Europe
Despite severe recession risks, the European Central Bank raises rates 75 bps
Typically, in the face of a potentially severe economic downturn, a country’s (or region’s) central bank will begin lowering interest rates in response. In an illustration of just how wrongheaded the ECB’s decision was to go negative with interest rates back in 2014, Europe’s central bank has been forced to do just the opposite: raise rates. It began back in July, when the ECB raised its deposit facility interest rate from -0.5% to 0.00%—a 50-basis-point hike. Now, due to runaway inflation (primarily caused by the energy crisis), the bank has been forced to match the Fed’s most recent action and raise rates another 75 basis points, to 0.75%. In addition to putting downward pressure on inflation, this move should also shore up the euro, which recently dipped to parity with the strengthening US dollar.
The irony of the ECB’s needed move is that the European Union is simultaneously pumping hundreds of billions of euros into the economy to help families deal with skyrocketing energy costs. Basic economics says that when a central government pumps money into an economy, inflation naturally increases. Eurozone inflation rose to 9.1% in August and is expected to hit double digits in September. The ECB, like the Fed, has an inflation target rate of 2%. It has a long way to go before getting anywhere near that number, unless a severe recession grinds the European economy to a halt.
It has been a full decade now since the key European rate has been above zero. ECB President Christine Lagarde, meanwhile, has signaled more hikes to come. These hikes are needed, but they will only increase the likelihood of a deep recession hitting the continent this winter.
Fr, 02 Sep 2022
Economics: Work & Pay
Two key positive takeaways from the August jobs report: unemployment and labor force participation
Here was the conventional thinking as investors awaited the August jobs numbers: if the report was strong, the Fed would continue hiking rates and stocks would be punished; if the report was weak, the Fed might start tapping on the brakes and stocks would celebrate. We ended up with something in the middle, and that was the best possible outcome.
First the headline number. There were 315,000 new nonfarm jobs added in the month of August, or slightly fewer than the 318,000 expected. Wages rose 5.2% from a year ago—not a positive sign for inflation, but not as much as expected. There were two key components of the report that helped turn futures from flat to positive. The first was the unemployment rate, which surprised analysts by ticking up from 3.5% to 3.7%. The second was the reason for that jump: the labor force participation rate rose an impressive 0.3%, to 62.4%. That may not seem like much, but it meant another 800,000 Americans began looking for work.
One of the biggest causes of inflation has been the scarcity of workers, forcing employers to pay more to attract new help. That pool of workers just got a lot bigger, which should help dampen the recent wage spikes. The prime-age labor force participation rate—workers between 25 and 54—surged to 82.8%, which is great news on that front. Overall, it is hard to imagine a much better report rolling in right now.
We still want—and expect—to see a 75-basis-point rate hike coming in September, which would bring the upper band of the Fed funds rate up to 3.25%. We still need to see any combination in subsequent months pushing that rate up to 4%. Then, it will be time to pause until inflation moves back down to an acceptable level. The Fed will also be reducing its $9 trillion balance sheet over the coming year. To be clear, this scenario is what needs to happen, not what the market wants to see.
Mo, 29 Aug 2022
Industrial Conglomerates
3M wanted bankruptcy court for one of its subsidiaries; a judge denied the request
Between 2003 and 2015 a 3M (MMM $126) subsidiary by the name of Aearo Technologies manufactured and supplied earplugs to the United States military for troop training and for troops stationed in a combat environment. Production of the earplugs, which were unique in their two-sided design, ceased in 2015. In 2016, a competitor filed a whistleblower lawsuit claiming that 3M knew the plugs were defective, causing hearing loss and tinnitus in scores of soldiers. Two years later, the company agreed to pay over $9 million in a victims’ fund. After that tiny amount was paid, some 230,000 service members began filing lawsuits against the firm; the suits were ultimately consolidated through multidistrict litigation (MDL, somewhat akin to a class action lawsuit but more personalized) and handed off to a bankruptcy court in the Northern District of Florida.
In an effort to limit its own liability, 3M declared bankruptcy for its Aearo Technologies unit and threw a gauntlet down to the judge, arguing that it was not within his power to interfere with the proceedings. The judge did not share that opinion. Shares of the company plunged nearly 10% after Judge Jeffrey Graham denied 3M’s attempt to offload the company’s problems in such a manner, keeping the parent company on the hook for a potentially enormous payout. While the cases which have already gone to trial present a mixed picture, it is easy to imagine the ultimate payout to a large percentage of 230,000 plaintiffs dwarfing the $1 billion amount the company has since set aside for settlement. For example, in ten cases which have already been decided, five were won and five were lost by the company, with the successful plaintiffs being awarded between $1.7 million and $22 million each. Here’s a staggering fact to consider: If one out of every three plaintiffs in the case were awarded $1 million, the dollar amount would be roughly equivalent to 3M’s market cap.
Over the course of the past nine years, 3M shares are flat. They were trading at $126 back in 2013, and they trade at $126 right now. The company is trying to pull a General Electric (GE $76) move by spinning off its healthcare business (the current GE shouldn't be used as a model for anything, except what not to do), arguing that long-term shareholder value will be created. We don’t buy it. As for the stock, we offer the same recommendation—don’t buy it.
Fr, 26 Aug 2022
Market Week in Review
There are well-founded market drops, and then there are the type that happened Friday
Did investors really believe Jerome Powell was about to pivot and become a dove? Perhaps they were expecting him to come out in front of the gorgeous mountain range at Jackson Hole and proclaim, “Inflation is no longer a threat or a problem, we must get rates back to zero!” Complete silliness. Instead, he did what everyone should have fully expected: In front of some wood paneling straight out of the ‘70s (fitting), he said that the Fed will continue to do everything it must to tame inflation. It was short and sweet…and correct. For us, that means the terminal Fed funds rate will be at least 3.5%, but we are hoping for 4%. If the markets can’t handle a 4% rate, then we have really dumbed down our economy.
Think of the trillions of dollars pumped into the economy by the Fed and the US Congress over the past few years. Does anyone other than a full-blooded, card-carrying Keynesian believe that is healthy for a country, an economy, the stock market, or individuals? No! Sure, we had to take extraordinary steps in response to the pandemic from China, but did it need to continue for two years? Furthermore, what about the $23 trillion worth of debt the government had built up before it added $7 trillion more post pandemic?
The market should have cheered a responsible Fed Chair following in Alan Greenspan’s footsteps and telling us he will do whatever it takes to staunch inflation. Instead, the Dow lost 1,008 points on the session, or 3%. In fact, all four major benchmarks (to include the Russell 2000) lost over 3%. Something to worry about? We believe just the opposite. Investors are myopic. Powell gave then exactly what they needed (a responsible policy), not what they wanted (a shiny early Christmas present), and after the temper tantrum we will be back on the upswing. Friday wasn’t a day to worry; it was a day to identify strong companies which have been senselessly beaten down.
Th, 25 Aug 2022
Global Strategy: Europe
Europeans face a harsh winter thanks to skyrocketing energy prices
Americans have certainly noticed their energy bills rising this year, and the problem will be exacerbated this winter when most households switch from their electricity-powered a/c to natural gas-powered heating systems. In fact, one in six American households now have overdue utility bills—the largest percentage on record. But Americans’ problem is nothing compared to that of their European counterparts, who now face an astronomical spike in energy prices.
The long-term average price in US dollars for one million British thermal units (MMBtu) of natural gas imported into Europe is $4.20. Today, that figure has skyrocketed some 718%—to $34.35—from its average. Electricity rates in Germany are now six times higher than they were last year, while the French are facing €900/megawatt-hour energy prices—ten times the cost as last year. France’s issue has been magnified due to its nuclear energy problems—over half of the country’s reactors are offline due to maintenance, repair needs, or river issues (reactors need massive amounts of river water for cooling; water levels are low right now, and temperatures are unusually high). While governments grapple with how to best help their citizenry with out-of-control prices, there are no easy answers. The long, hot summer in Europe will morph into a frigid and painful winter, much to Putin’s delight.
We have been underweighting both developed and emerging markets in Europe due to a host of economic issues. First and foremost is the continent’s massive energy crisis; a problem which came about due to an overreliance on Russia for its needs. Perhaps France and Germany will learn from this, but it will take years for the problem to be resolved.
Th, 25 Aug 2022
Specialty Retail
“Diamond hands” traders just got screwed over by mentor on Bed Bath & Beyond
By now, we all know who and what “diamond hand” traders are: people who follow social media sites like r/wallstreetbets, buy the flailing companies touted in an effort to crush short sellers, and then hang onto the shares no matter what. One of their recent champions has been Ryan Cohen, the activist investor who took a major stake in Bed Bath & Beyond (BBBY $10) back in March through his RC Ventures hedge fund. Shares of the home retailer rocketed from $15 to $30 as diamond hands piled in. Subsequently, however, as it became clear just how bad the financials were for the company, negative headlines and downgrades pushed the shares down to the $4 range. Cohen was sitting on a huge loss (he owned about 10% of the shares at that point). His firm then purchased call options on nearly 1.7 million shares of BBBY, driving the price back up to the $30 range. Then, Cohen did what no self-respecting diamond hands trader would do: he sold his entire position. This caused the shares to tumble 52% over the course of two days, leaving the hedge fund manager with a $68 million profit and his followers with enormous unrealized losses. Cohen’s investment firm had no comment.
Will Cohen’s actions at BBBY make many meme stock traders reconsider their “strategy?” Probably not. For investors who are serious about their portfolios, however, this story buttresses an important tenet: Understand the companies you are buying, what their unique value proposition is, and whether or not they will have the financial wherewithal to navigate any economic environment. And never have diamond hands—never hesitate to take profits and minimize losses.
Tu, 23 Aug 2022
National Debt & Deficit
Your government spent $2.775 trillion more than it collected last year
If we talk about enormous sums of money too often the brain begins to accept them; or, at least, gloss over them. That is not good. We need to understand the fiscal irresponsibility of our elected officials to have any hope of changing their actions. So, instead of simply saying that this country is currently $30.7 trillion in debt, let’s try this fact: If each US taxpayer were directly responsible for their portion of America’s debt, we would owe $244,315 apiece. Want to add your kids and other non-taxpayers into the mix? In that case, every US citizen owes $92,272.
Keeping in mind that 2020—not 2021—was the year we bore the brunt of the pandemic from an economic standpoint, consider how much the US government collected and spent last year. Revenue collected came in at $4.045 trillion. Last year the government spent $6.820 trillion. The difference, or deficit, is how much we grew the national debt last year: $2.775 trillion. At the risk of being redundant, our government spent $2.775 trillion more than it took in last year, in the midst of a rip-roaring economy. What is even more disgusting is that Social Security inflows and outflows are wantonly thrown into the mix rather than being physically separated, as they should have been from the start, from the general funds. Were your company to do that with your 401(k) plan, it would be a criminal act.
Understandably, the largest deficit on record took place in 2020. There is no excuse, however, for 2021’s budget-busting numbers. And as interest rates rise, it is going to take a bigger and bigger portion of revenue to simply service the interest on the national debt each year. Right now, a “paltry” ten cents out of every dollar collected goes toward interest payments. Imagine ten cents out of every dollar you earn going towards the interest on your credit card debt! Madness.
There are two ways this slow-moving (actually, not-so-slow-moving) train wreck can be avoided: the positive way via a balanced budget amendment and term limits added to the US Constitution, or the negative way through a fiscal meltdown. The fallout from the latter is hard to fathom.
Mo, 22 Aug 2022
Work & Pay
A wave of layoffs are probably coming soon; how will that affect unionization efforts?
Consulting firm PwC polled over 700 executives from US firms in all industries and of all sizes, and they found that over half plan to reduce headcount and implement hiring freezes within the coming months. While it may seem counterintuitive, many also said they plan on simultaneously increasing their number of contract workers and freelancers. Dig a bit deeper, however, and that makes perfect sense. With a slowing economy, higher inflation, and supply chain issues, many firms suddenly find themselves dealing with a renewed unionization push. And this time around, it is not just industrial names which are in the crosshairs. Consumer discretionary companies like Starbucks (SBUX $87), which are known for their generous benefits like tuition assistance, are bearing the brunt of the push. That is illogical, and we fully expect the inevitable increase in the 3.5% unemployment rate to help quell the movement.
Technology will also play a role in dampening successful activism, as advances allow firms to be more productive with a smaller headcount. A McDonald’s (MCD $266) restaurant, for example, might add new ordering kiosks, while an Apple (AAPL $169) might reduce its physical footprint in favor of an enhanced online presence. This is not the 1970s: Companies now have levers to pull in order to maintain their productivity levels—tools which were simply not available back then.
Speaking of productivity, it has been going down recently for the first time in a long time, and new studies are indicating that work-from-home is playing a role in the drop. This is one of the reasons why companies such as Apple are now demanding their workers return to the office at least two or three days per week. Right now, that mandate is limited to the area around Apple’s Cupertino headquarters, but we expect the requirement to expand into other areas soon. The back-to-work request has been a hard one to enforce with the low unemployment rate, but now that stimulus funds are depleted—and as the unemployment rate rises—expect more of these policies to come down the pike. We imagine a large percentage of those 700 executives will be watching Apple’s initiative with interest.
There is a natural ebb and flow to the unionization movement in America, with undercurrents such as the political environment and economics (the unemployment rate) affecting the efforts. Right now, corporations appear to be up against the ropes, but time and technology are on their side. This is especially true for the companies who treat their employees as fellow stakeholders rather than simply a line on a balance sheet.
Tu, 16 Aug 2022
Food & Staples Retailing
Walmart shares pop 5% after the company tops estimates and sticks to full-year guidance
It was just under a month ago that Walmart (WMT $140) shares plunged following dire management warnings on crimped profit margins due to inflation and a consumer who was cutting back on discretionary spending. The shock waves from those comments were felt throughout the industry. This week, we received a different story line. Walmart shares gained over 5% on Tuesday’s open following a revenue beat ($153B vs exp. $151B), an earnings beat ($1.77EPS vs exp. $1.63), and an improved outlook for the full year. Same-store sales at its flagship stores rose 6.5% in the quarter, while Sam’s Club saw a 9.5% gain. CEO Doug McMillon said that the company is now effectively working through the inventory problems which were at the heart of July’s lowered guidance. McMillon also said that behavior changes due to inflation are driving higher-income households into Walmart stores. Whatever the reason, the Street remain generally bullish on the company: out of 39 analysts, 20 have a buy rating and none have an underperform or sell rating on the shares.
Walmart is one of the 40 companies within the Penn Global Leaders Club.
Tu, 16 Aug 2022
Global Strategy: East/Southeast Asia
China cuts rates as economy slowing on nearly all fronts
Consider this: The US economy is slowing and layoffs are increasing, but the Fed remains committed (correctly so) to rate hikes; the European Union faces an even more severe economic slowdown and a brutal coming winter due to a Russian-fomented energy crisis, and the ECB is raising rates; China’s economic growth rate is slowing on nearly all fronts, and the People’s Bank of China just cut rates. That unexpected action by China’s central bank highlights the dichotomy between how the West and the East are dealing with an unwelcome mix of high inflation and probable recession.
While China didn’t cut its interest rates by much (the main rate at which it provides liquidity to banks dropped from 2.1% to 2%), the government simultaneously announced it was pumping an additional $60 billion into its financial system to spur lending. The challenge with both of those moves is the fact that Chinese citizens are very reluctant to borrow right now due to angst over lockdowns, an economic slowdown, and a nightmarish real estate market. (The government is placing strict controls over the sale of properties by homeowners, adding to the apprehensiveness of would-be buyers.) For a communist party which bases its very existence on control, the inability to get its people to act in a certain way must be maddening.
As for the economic slowdown in the country, economists are rushing to downgrade expected rates of growth. TD Securities, for example, just lowered its full-year GDP expectations to 2.9%, while UBS admitted to seeing “downside risks” to its 3% full-year growth forecast. Unlike the American consumer, which has been full steam ahead, Chinese consumers have purchased around half of the retail goods economists had expected by this point in the year. And there are scant indications that the situation will get better anytime soon.
Of course, US retailers who became overly reliant on Chinese sales will also be hurt by the country’s economic slowdown. That fact, combined with the strong US dollar, should have investors searching for small- and mid-cap consumer cyclicals which receive the lion’s share of their revenues from domestic sales.
Mo, 15 Aug 2022
Media & Entertainment
Clown company: You couldn’t give us shares of Getty Images Holdings
How fitting that Getty Images Holdings (GETY $31) went public via a SPAC—it certainly would have been a humorous roadshow full of fanciful tales of projected growth had they been forced to use the traditional process. It is also fitting—and sad—that “investors” pumped the value of the shares up from $10 to $31 since this joke of a company went public late last month. Getty, whose shares are worth—in our opinion—about $1 apiece, now has a market cap of $11 billion. Do people literally have money to burn?
As the name implies, Getty Images sells stock images to creative professionals, the media, and corporations. Protecting copyright infringement is serious business, but Getty has turned it into a nefarious source of revenue. Examples of the firm’s abuse of power are too numerous to mention, but here is a rather typical scenario: A photographer uses one of their own digital photographs on a website. Not long after, the photographer receives a demand of payment from Getty for using the photograph; the demand comes with a threat of legal action unless the confiscatory amount requested is paid immediately. The photographer takes legal action to get the threats stopped, as they created the very image in question! The company also uses embedded technology within images to “go fishing” for people who might use the images, thus initiating the demands for payment.
The last thing Getty wants is for people to call their bluff and demand that a court decide an outcome—the company has lost a string of cases, drawing rebukes from the courts. Getty also has a well-documented history of taking images in the public domain (“free use”) and leasing them to unsuspecting customers for up to $5,000 for a six-month term.
For any investors believing they will own a piece of a growing enterprise, consider the fact that this is not the first time Getty has been publicly traded, and that only twelve shareholders own nearly 80% of the company. It may be legal, but it is a scam in our books.
Getty is the sort of company that would love to sue anyone with a disparaging view of their operations. The New York Stock Exchange should have steered clear of this listing, and investors should run the other way.
Th, 11 Aug 2022
Economics: Supply, Demand, & Prices
At long last, the steep inflation trajectory is beginning to moderate
Within seconds of the report’s release, Dow futures soared more than 400 points—led by consumer discretionary names. Finally, after months of ever-growing rates, inflation cooled in July. Following June’s 9.06% YoY rate and 1.32% MoM rate, and against expectations for an 8.7% annual increase, the price of goods and services in the US rose by “only” 8.5% in July. The MoM number, which was expected to rise by 0.2%, actually fell by that precise amount. While the 7.7% drop in gas prices in July helped drive that number down, even when energy and food prices are excluded core CPI still rose less than expected: 5.9% versus the 6.1% expected. Housing costs, which make up around one-third of the CPI, rose 5.7% from a year ago.
The report brought a sigh of relief to investors, as the Fed has indicated it will continue raising rates until it tames inflation. Any number above consensus would have increased the odds for an even greater rate hike at the September FOMC meeting. Another 75-basis-point hike is still expected, followed by two or three smaller hikes before the end of 2022. Buttressing the good news on the consumer side of the inflation front, the producer price index (PPI)—a reflection of what producers of goods and services must pay—also fell in July. Instead of the expected 0.2% jump MoM, prices actually fell 0.5% from June.
One month does not a trend make, but we believe peak inflation is now behind us. Now, the move downward must be gradual enough so as to not create a more dovish Fed before rates get back up to where they should be. We need decent bond yields in order to build well-balanced portfolios.
We, 10 Aug 2022
Consumer Electronics
Amazon is buying iRobot for $1.7 billion
We were early investors in consumer robot company iRobot (IRBT $59), initially buying shares of the company shortly after they went public. It has been a wild, seventeen-year ride for those shares, coming out of the gate around $24, rising all the way to $197.40 in the spring of 2021, and then falling back to $35.41 a few months ago. We actually took our profits around $65 per share (we owned the company in the Penn New Frontier Fund) when a stop loss hit. Now, the maker of those cute little Roomba autonomous vacuums, Braava robot mops, and (coming soon to a backyard near you) Terra robot mowers is being acquired by Penn member Amazon (AMZN $138) for $1.7 billion in cash—around $61 per share. We love the deal.
Amazon’s Alexa already supports iRobot devices (“Alexa, ask Roomba to start vacuuming”), and now the enormous, $1.4 trillion e-commerce company can provide the needed cash inflow for the development of new devices. iRobot has faced a number of headwinds lately, to include tariffs (it is now moving a large portion of its manufacturing operations from China to Malaysia), rising input costs, supply chain issues, and an unanticipated drop in demand due to deteriorating global economic conditions. While the firm has generally operated in the black over the past decade, Amazon’s deep pockets will assure the company is able to weather a recession and come out stronger during the next recovery phase. The deal is expected to be completed by the end of the year.
Talk about a great marketing platform for iRobot: being highlighted by the world’s largest e-commerce company should provide a great catalyst for future sales. As for Amazon, it remains one of our highest-conviction holdings. We added to the position following the stock split (when shares were trading around $100) and have a price target of $200 on the shares. Amazon is one of the 40 holdings within the Penn Global Leaders Club.
Fr, 05 Aug 2022
Market Pulse
At first, the market hated the
Sa, 29 Oct 2022
Market Pulse
The foolishness of the mainstream media was on full display this week
Back in July, as the market was rebounding from its June lows, CNBC’s Jim Cramer frantically declared, “The market hit its bottom on June 16th!” Of course, he was proven wrong just a few months later. After the September bloodbath, Jim Cramer told his viewers that he had been talking to a lot of “big investors,” and they were all telling him the S&P 500 would take out 3,000 on the way down, and that the fed funds rate wouldn’t stop until it hit 6%. At the time, the S&P 500 was at 3,657 (we looked at the ticker the minute he made his rant). This was before what is shaping up as the best October in decades.
Yes, big tech got hit this week on weaker-than-expected earnings and some sobering guidance. But let’s take Apple (AAPL $156) as an example of just how reactionary the press really is. The minute the Cupertino-based giant announced a miss on iPhone 14 sales, and that revenue growth could slow during the coming holiday season, AAPL futures dropped some 8%. Immediately, the panel of esteemed hosts on a certain business channel began falling all over themselves to explain why the stock was down, how they saw this coming, and the bad things it portended for Apple as a company. The next day, instead of following through on the 8% drop, Apple shares climbed 8%—a 16% swing from the post-earnings futures. You would think these individuals would stay mum based on their previous afternoon’s comments. No, instead they doubled down on their dumb comments.
We find it highly impressive that, following some rather glum reports and guidance, all the major benchmarks were up this past week—including the Nasdaq (where the tech giants live). While we still haven’t clawed back September’s brutal losses, we are making good progress. This tells us investors believe a couple of things: that the Fed is going to do another 75-basis-point hike next week but then indicate a slowdown of the rate of increases; and that earnings are not coming in nearly as bad as feared, despite the FAANG disappointments. We believe they are correct on both counts. Too late to go back and declare another market bottom in September, Cramer, that ship has sailed.
We believe we are in the early stages of a Santa Claus rally, buttressed by a Fed slowing its pace and by the mid-term elections. Who will lead the charge? Probably the small caps, which have been severely beaten down and are spring-loaded for a comeback.
Fr, 28 Oct 2022
Aerospace & Defense
Boeing, led by its inept management team, fumbled yet another quarter away
The once-great American aerospace giant Boeing (BA $135), led by bumbling CEO Dave Calhoun, has announced yet another lousy quarter. Against expectations for $17.8 billion in sales, the company brought in just $16 billion; from that $16 billion, the company managed to lose $3.275 billion along the way. Put another way, the Street was expecting earnings per share of $0.10, instead it delivered a $5.49 per share loss.
While the bottom-line net income still would have been negative, the enormous loss was overwhelmingly a result of a $2.76 billion hit the company took on the aggregate of five fixed-price development programs, to include the (nightmarish) KC-46 tanker program and the (long delayed) Commercial Crew program. The KC-46 USAF tanker program alone accounted for a $1.17 billion loss. Are you ready for the “leader’s” response? CEO Dave Calhoun said the charges were driven by macroeconomic forces beyond Boing’s control. Way to take ownership, Dave.
The concept of the learning curve with respect to huge companies building complex systems states that costs go down with the repetition of a smooth-running assembly line. Calhoun said, “We don’t have any baked-in learning curves anymore.” True, you obviously don’t. What you didn’t say was that it is all management’s fault. It is hard to BS your way through the publicly traded landscape: Boeing has lost 70% of its value since 01 March 2019. How about an apples-to-apples comparison: Boeing’s disastrous finances are reflected in its -3.25 debt/equity ratio; Airbus (EADSY $26) has a debt/equity ratio of 1.32. We suppose the “macroeconomic environment” is rosier in Europe?
There is a fiefdom at Boeing, with Calhoun having anointed himself king and the jesters on the board facing little pushback from the poor citizens (shareholders). Until the autocratic regime is overthrown, there is no reason to own shares of this once-great company.
We, 26 Oct 2022
Interactive Media & Services
Snap continues to disappoint the Street; is the stock now cheap enough to buy?
It is becoming a quarterly ritual: Snap (SNAP $10) reports earnings, and we report the company’s double-digit share price drop. It just happened again. Last Thursday, for the third consecutive quarter, Snap missed on both revenues and net income, generating $1.128 billion in sales and losing $359.5 million in the process. Management then proceeded to give an outlook so lousy that the company’s shares gapped down some 28% on the day. While they have climbed back a bit from their new 52-week low of $7.33, investors shouldn’t be too eager to jump in at these “bargain basement” prices (shares remain down 80% for the year).
Snap has an impressive base of 158 million daily active users, but the company generates nearly all its revenue from advertising; and 88% of those ad dollars emanate from US companies. After surprisingly bad numbers from much larger competitor Alphabet (GOOG $105), particularly in its Snap-like YouTube unit, expect a rough year ahead as the US muddles through a recession. Digital ad spends are among the easiest cuts made by corporations as they hunker down in preparation for an economic downturn, and Snap would be an easier advertising cut to justify as opposed to a pullback in online ads at Google, for example. In short, we fail to see any near-term catalysts that would drive the shares substantially higher from here.
We have discussed the comically skewed share class structure (in favor of management) at Snap, so no reason to rehash it now. Suffice to say investors looking for deals among the tech carnage can find better opportunities elsewhere.
Mo, 24 Oct 2022
Global Strategy: Europe
Labour will have a much tougher time trying to discredit the new UK prime minister
Including the one just selected, there have been eight prime ministers of the United Kingdom since Maggie Thatcher left that post in 1990; seven have been Tories (Conservative Party), and one has been a member of Labour. The newest resident of 10 Downing Street, Rishi Sunak, has made it clear who he most idolizes: Margaret Thatcher.
On its face, the optics of having been through four Conservative Party PMs within the last three years and three within the past seven weeks should bode well for Labour going into the next general election, which must be held no later than early 2025 (the last, held in December of 2019, was a landslide victory for the Tories). But Rishi Sunak is no Theresa May, nor is he a Liz Truss; the left will be in for a bit of a surprise as they feign insult at every turn and begin their interminable attacks.
At age 42, Sunak will be the youngest prime minister since William Pitt the Younger assumed office—at age 24—in 1783. Indian by heritage, Sunak’s mother was a pharmacist and his father was a general practitioner in the National Health Service. After graduating from Oxford, he received his MBA from Stanford while living in the United States. Although he was Boris Johnson’s chancellor of the Exchequer (think Treasury secretary), he resigned this past summer after questioning his boss’ ethics. He has experience in the world of investment banking, working at Goldman Sachs and as a hedge fund manager in the US.
Following in his idol’s footsteps, Sunak believes in lower taxes and controlled government spending; though he did oversee the massive furlough program which made payments to the millions of Britons who lost their jobs during the pandemic. He enters office at a critical period, as economic conditions in Great Britain continue to deteriorate. Facing the twin culprits of weak economic growth and rampant inflation (stagflation), his honeymoon period will be short. However, his real-world experience in finance should serve him well, despite the loud and obnoxious voices of his critics.
Rishi Sunak may never breathe the rarefied air of the Iron Lady, but we expect him to be a highly effective PM—to the chagrin of his haters. We will also make the bold prediction that he will still be in power for the next general election, which he will proceed to win. For investors wishing to take advantage of an economic rebound in the UK, look at EWU, the iShares MSCI United Kingdom ETF. One of its top holdings—Diageo PLC (DEO $165)—is an inaugural member of the new Penn International Investor fund.
We, 19 Oct 2022
Commercial Banks
Credit Suisse looks a lot like Lehman in 2008; could the global bank really fail?
Credit Suisse Group AG (CS $5), founded in 1856, is one of the two major Swiss banks and an important player in global finance; the Zurich-based firm maintains offices in all major financial centers around the world. Going into the 2008 global financial crisis, the bank had a market cap of $90 billion; today, it is a shell of its former self, boasting a market cap of just $12 billion. While it survived the global banking crisis, recent scandals have driven investors away and have some analysts handicapping a nightmare scenario: insolvency.
The recent scandals began when British financial services firm Greensill Capital, in which Credit Suisse had some $10 billion invested, went belly up, causing CS clients to lose around $3 billion. Then came the Archegos Capital (Bill Hwang) debacle. While the privately held company primarily managed the assets of family office group trader Hwang, CS was a major lender to the firm. As Archegos was imploding and before Hwang was arrested for securities and wire fraud, the company lost $20 billion in a matter of days. Credit Suisse itself was out $4.7 billion, causing a half-dozen executives at the bank to lose their jobs. In February of this year, the bank was charged with money laundering (it was later found guilty by a Swiss court) in connection with a Bulgarian drug ring. Shortly after that, details of approximately 30,000 customer accounts at the bank—worth over 100 billion Swiss francs in aggregate—were leaked to a German newspaper. The leaks exposed customers involved in all types of lurid behavior, from human trafficking to torture. Finally, and most recently, it was discovered that executives at the bank urged certain investor-customers to destroy documents linked to Russian oligarchs who had been sanctioned following the invasion of Ukraine.
This past summer, Credit Suisse Chairman Axel Lehmann replaced the bank’s CEO with its head of asset management, Ulrich Koerner, and announced a strategic review of its investment banking unit. The bank’s upcoming earnings release—slated for 27 October—is expected to show a reduction in the bleeding from Q2, but that will not be enough to quell investors. A comprehensive restructuring plan is needed, but we doubt the current management hierarchy is up for the job. That said, we don’t believe the bank faces any real threat of insolvency—it is “too big to fail.”
There has been some intriguing speculation recently that the other major Swiss bank, UBS (UBS $15), with its $52 billion market cap, could swoop in and save Credit Suisse via a merger. While we don’t see that scenario playing out (Swiss regulators would not be keen on the idea), a positive upside surprise on the 27th could move the shares higher. Analysts run the spectrum of expectations, from CFRA’s $3.50 price target to Morningstar’s $10.60 fair value. While it may be fair to say the company is not going the way of Lehman, the risk of it languishing while management tries to clean up its mess is too great to justify an investment—even at $4.58 per share.
Tu, 18 Oct 2022
Social Security, Medicare, & Medicaid
Social Security recipients will receive their largest increase in four decades next year
In the face of soaring inflation, the Social Security Administration has announced that beneficiaries will receive an 8.7% cost of living increase in 2023—the largest adjustment since 1981’s 11.2% bump. This move comes on the heels of a 5.9% upward adjustment in 2022. On average, next year’s rate increase will amount to $146 more per month in recipients’ bank accounts. Additionally, Medicare Part B premiums, which are generally deducted from Social Security benefit payments, will be lowered next year from $170.10 to $164.90. Approximately 50 million Americans receive Social Security each month, with another ten million receiving disability payments and six million receiving survivor payments. The average payment for retired workers in 2022 is $1,670, while survivors average $1,328 per month. Per Social Security Administration figures, total income collected for the Social Security Trust Fund last year was $1.088 trillion, with $1.145 trillion going out in the form of payments—a $56 billion deficit. At the end of last year, the Fund had $2.852 trillion in asset reserves.
In early 1968, President Lyndon Baines Johnson moved the Social Security Trust Fund “on-budget,” meaning it would be considered part of the unified budget of the United States. In 1990, under President George H.W. Bush, this action was reversed, moving the Fund back “off-budget.” To see income, outflow, and reserve levels of the Fund, readers can visit the Social Security Administration website.
Tu, 11 Oct 2022
Government Watchdog
The rotten law that California voters rejected is about to be shoved down America’s throat
Think of how the likes of Uber (UBER $25) and Lyft (LYFT $12) have radically transformed—for the better—transportation in this country. Bargoers who wouldn’t have considered calling for a Yellow Taxi at two in the morning routinely hail rides on their app. Elderly shoppers in suburban regions can now get a convenient and reasonably priced ride to and from the grocery store. Apparently, that is a transformation which must not be allowed to stand.
The subversive movement to halt this positive trend began, fittingly, in California. Assembly Bill 5 (AB5) said that all workers, to include drivers for ride-hailing services, had to be considered employees of the company rather than freelance “gig” workers. Never mind the fact that most of these drivers did not wish to be considered employees. Then came Proposition 22, passed by a majority of California voters, which exempted these workers from being classified as employees rather than independent contractors. Understandably, Prop 22 was a major win for the industry.
Since such an important issue cannot be left to the masses to decide, the results immediately came under fire. A California judge ruled the measure unconstitutional. The battle rages on, but now the White House has chosen to take a stand on the issue. President Joe Biden has ordered his Department of Labor to review how workers are classified. In short, the administration wishes to codify, on a national level, California’s AB5. As this move would cause operating costs in the industry to skyrocket, shares of Uber and Lyft plunged on the news. Other companies in industries from trucking to construction also dropped on the DOL proposal. An attorney for the department said the move was “not intended to target any particular industry or business model.” Is anyone dense enough to believe that?
As we are on the precipice of a recession, what an incredibly thickheaded time to go forward with such anti-business nonsense. There will be an endless stream of legal challenges to the coming decree, and we expect the final decision to be made by the US Supreme Court. In the meantime, we have yet another roadblock in the way of getting our economy back on track.
Tu, 11 Oct 2022
Automotive
It has been a rough road for Rivian since its IPO, and that was before the massive recall
Talk about lousy timing. Last November, one year ago next month, signaled the peak in the stock market, and it has been a bumpy downhill slog from there. Last November was also when EV maker Rivian (RIVN $31) presented itself to the investment world via an IPO. Initially priced at $78, shares quickly soared to $179.47 on 16 November, just six days after the IPO. Woe to any investor who jumped in then: the current stock price represents an 83% drop from that all-time high.
In a tough economic environment, marred by supply chain issues and rising input costs, Rivian has been consistently missing its own production targets; now, on top of that, the company is being forced to recall nearly all its vehicles on the road for steering control issues. While there have been no reported injuries and the fix is relatively straightforward, the problem will divert precious resources away from production at a time when the startup is already under intense scrutiny for over-promising and under-delivering.
The first Rivian rolled off the assembly line in September of 2021, and the company has produced just 15,000 vehicles to date. The 2022 full-year production target is 25,000 vehicles, which is all but guaranteed to be another miss. Rivian has a market cap of $28 billion, down from a November high of $153 billion. The company's R1S electric pickup has a price range between $72,500 and $90,000, while the longer-range R1T, fully loaded, will set a buyer back around $100,000.
For those who believe Rivian is the next Tesla, $31 per share may seem like a great point at which to buy the stock. While the company has enough cash on hand to weather the production and recall problems, the potential for further price erosion is too great to justify an investment right now. For those willing to take the risk in the automotive industry, Ford (F $11) looks a lot more attractive with its 5.668 forward multiple.
Sa, 08 Oct 2022
Market Pulse
It was a positive week in the markets, so why didn’t it feel that way?
The week began with the best two-day rally since April of 2020, with the S&P jumping some 5.6%. A few signs arose which gave the market hope that inflation was starting to be tamed, which might lead to the end of rate hikes. Wednesday was flat, Thursday investors began to worry, and Friday’s strong jobs report capped the U-turn. The unemployment rate fell from 3.7% to 3.5%, the labor force participation rate remained steady at 62.3% (we need more workers rejoining the labor force), and 263,000 new jobs were created—more than anticipated. We are back to the bizarre world where good news is bad news. This all but assured more rate hikes, with odds strong for a 75-basis-point hike in November, followed by a 50- and then 25-bps hike in December and January, respectively. That would put the upper limit of the fed funds rate at 4.75%, at which time Powell and company should be able to put the tightening on hold.
That probable scenario spooked the Dow into a 630-point selloff on Friday, which is absolute silliness. A 4.75% rate is not economy crushing, as we have weathered much higher rates in the past. The average 30-year mortgage loan now comes with a 7% APR, which has certainly dissuaded homebuyers and seized up the refinance business; but runaway home values are beginning to level out—an important component to controlling inflation. Another big weight on the markets this week came courtesy of OPEC, which promised to curb oil production by two million barrels per day. The cartel’s aim is to stick it to Biden while getting oil prices closer to triple digits, and it seems to be working: the price for a barrel of crude rose from $79.74 before Monday’s open to $93.20 by Friday’s close.
By the end of the week the Dow had actually pulled off a 1.99% gain, followed by the S&P 500 at +1.5% and the NASDAQ at +0.72%. Market emotions were on full display over the five-session period, going from hopeful anticipation on Monday to depressed capitulation on Friday. It may seem odd, but these kinds of wild swings are often the precursor of something good waiting around the corner.
It has been a painful year, but we are now in the bottoming-out process. When the market senses that the Fed is near the end of tightening, there will be a rally akin to the one we experienced during the vaccine phase of the pandemic. Barring, of course, a cornered Russian thug doing something even more horrific than he already has.
Th, 06 Oct 2022
Beverages, Tobacco, & Cannabis
Cannabis stocks rocket after Biden requests drug classification changes
It was one of the moves North American cannabis producers have been anxiously awaiting: President Biden has formally requested a review of how marijuana is classified under US law. He further requested that governors move to pardon anyone in a state prison solely for marijuana possession (there are fewer than 10,000 incarcerated in federal prisons under these circumstances). Despite wild success in Canada and much of the rest of the world, leading producers such as Tilray (TLRY $4), Curaleaf Holdings (CURLF $6), and Canopy Growth (CGC $4) have been waiting for the mother lode of being able to freely sell their products in the richest market in the world. That dream is coming closer to fruition. While it will still be a largely states’-rights issue, a change in federal law would allow cannabis companies to access full banking services and list on US exchanges.
How did the publicly traded cannabis companies respond to the news? Our favorite, Tilray, run by the highly skilled Irwin Simon (founder of Celestial Seasonings), popped 31% in one session; the AdvisorShares Pure US Cannabis ETF (MSOS $12) surpassed even that performance, jumping 35% on the day. Granted, there is a long way to go before our laws on marijuana resemble those of our neighbor to the north, but investors should also keep in mind that this group has been absolutely hammered over the past year. The cannabis ETF, for example, is still down 65% year to date despite the enormous untapped potential of an open US market.
We mentioned Tilray, which is actually the result of a merger between the namesake company and Aphria. Not only did Simon oversee the purchase of SweetWater Brewing Company, he also spearheaded the purchase of Breckenridge Distillery, maker of the high-end line of Breckenridge bourbon whiskeys. We see cannabis-infused booze coming in the not-to-distant future.
Th, 06 Oct 2022
Energy Commodities
OPEC’s win-win solution: take a jab at Biden and get a spike in oil prices
To say there is no love lost between the Biden administration and the Kingdom of Saudi Arabia is quite an understatement. When Biden flew to Saudi Arabia this past summer in an effort to get the titular head of OPEC to raise production, the country responded with a slap-in-the-face promise to boost output by a paltry 100,000 barrels per day. Now that the administration is getting what it wants before the upcoming mid-term elections—lower prices at the pump—OPEC+ holds a meeting in which it announces a two million BPD production cut. Oil futures, which had dropped to the upper-$70s/bbl range recently, surged back into the upper-$80s. This was a win for not only Russia, which has navigated the oil ban by selling crude to its nation-state buddies China and India, but also for Saudi Arabia, which got another chance to poke Biden in the eye and get the price of oil closer to its target $100/bbl range.
The administration, clearly miffed, is responding in the feeblest of ways: promising to tap the US Strategic Petroleum Reserve yet again and discussing the possibility of easing sanctions on Maduro’s Venezuela. That is akin to a sweater-clad Jimmy Carter holding a fireside chat and encouraging Americans to turn down their thermostats in winter. The administration seems unwilling to take the correct course of action, which is to encourage—in deeds not words—increased production at home.
The two million BPD cut by OPEC will probably only amount to an increase of one million barrels, as many members of the oil cartel are not currently meeting their quota; that amount could be countered were the US to begin pumping the same amount it did back in early 2020. But the love affair between the US energy complex and the Biden administration is on par with the Kingdom’s affection for the president. Additionally, with the litany of recent regulations thrown against “big oil” and the cancellation of the Keystone pipeline, getting back to 13 million BPD would be extremely challenging in the short run. That leaves the greatest “hope” for reduced prices at the pump being a global economic slowdown—something nobody wants. With respect to energy prices, the US finds itself between a rock and a hard place, and American consumers will be the ones getting crushed.
The path of least resistance with respect to reining in oil prices seems to be a global economic slowdown. The regulations which have hampered oil production in this country will remain largely intact, and getting Venezuela back up to speed would take years. Also, consider the fact that there have been no new refineries built within the US for three decades, and the ongoing ESG battle against companies in the fossil fuels industry. That being said, if there is a marked slowdown in global growth we could see oil dropping back into the mid-$70s range this winter.
Tu, 04 Oct 2022
Interactive Media & Services
Twitter pops after Elon says he will buy the company under original terms
There have been a lot of crazy twists and turns in the Musk/Twitter (TWTR $52) saga, but we didn’t see this one coming. In a surprise move, Musk has said he will buy the social media platform under the original terms agreed upon: $54.20 per share, or $44 billion. Odds were stacked against him in the pending non-jury trial, slated to begin later this month, but it is rather strange that he did not come in with a lower offer. While it may not have been enough of a “smoking gun” to get him out of an ultimate deal, his argument that the company was hiding the enormity of the spam bots and fake accounts problem was substantiated by Twitter’s fired head of security—Musk’s key witness. While Twitter shares spiked 13% on the news and 20% in the ensuing days, the market cap still sits about $5 billion below the offer price. The press is making it sound as though Tesla (TSLA $242) shareholders hated the deal, but shares of the EV maker fell very little after the bombshell announcement. In the next issue of the Penn Wealth Report, we will delve into what Musk hopes to accomplish with his new platform. Hint: think indispensable “super app.”
We believe Musk can create a turnaround story at Twitter, a company which was never effectively monetized by erratic found Jack Dorsey and his hand-picked successor, Parag Agrawal. Of course, that will all take place (post deal) with Twitter as a privately held company. As for publicly traded Tesla, shares look like a steal at $242, and we maintain our $333 price target. We own Tesla in the Penn New Frontier Fund.
Th, 29 Sep 2022
Biotechnology
Biogen was down 18% year to date, then some good news sent shares soaring 40%
We are having a serious case of déjà vu with respect to $40 billion biotech firm Biogen (BIIB $277). Last summer, shares of the firm spiked some 55% on the back of positive news regarding its experimental Alzheimer’s drug, aducanumab. In the ensuing year, shares plunged 50%—from over $400 to under $200—on doubts about the therapy’s efficacy, despite FDA approval. This week it was a new Alzheimer’s drug from the firm, lecanemab, which moved shares of the firm back up some 40% in one session. Lecanemab, which was co-developed with Japanese biotech firm Eisai (ESALY $58), slowed cognitive decline in early-stage sufferers who were enrolled in the companies’ Phase 3 Clarity trials. Unlike the prior drug’s trials, which brought a good dose of skepticism from critics, these most recent results were universally hailed by the medical community. With the drug’s potential blockbuster status over the coming years, analysts were quick to upgrade shares of Biogen, though price targets remained relatively close to the day’s trading range. Among the 32 major houses covering the stock, 18 have Outperform or Buy ratings, while the other 14 have a Hold rating. The median price target on the shares is now $267.
Advances in the field of Alzheimer’s have been few and far between for the past two decades. Lecanemab holds a lot of promise, though we must now wait and see what type of support, via Medicare and insurance coverage, it will receive. We do believe, however, that the drug has the potential to generate over $1 billion in annual sales for Biogen.
We, 28 Sep 2022
Capital Markets
2021 was a banner year for IPOs, but most are not faring so well
There were some 400 companies that went public last year via the traditional route, with capital raised coming close to $300 billion. Add SPACs (special purpose acquisition companies) to the mix, and the number hits 1,000 new listings. So, how have these newly-publicly-traded entities been doing lately? The answer isn’t pretty. The Renaissance IPO Index is a basket of the largest, most liquid, newly-listed US public companies. Names like Snowflake (SNOW), Rivian (RIVN), Roblox (RBLX), and Coinbase Global (COIN) top the list. This index has an exchange traded fund, the Renaissance IPO ETF (IPO $29), which allows investors to buy into this basket with ease. Year to date, the fund’s value has been slashed in half, with the shares dropping from $60 to $30 in price. That represents more than twice the S&P 500’s plunge over the same time period. Here’s another staggering statistic: only about one in ten of the class of 2021 are trading above their IPO price. Market volatility due to inflation, rate hikes, supply chain issues, and fear of recession has pounded this group and dissuaded a lot of would-be players from going public this year. According to StockAnalysis.com, only 159 companies have gone public on US exchanges so far this year, or 79% less than the 767 IPOs which had taken place by the same time in 2021. As could be expected, this group has faced a similar fate. For anyone interested in scanning the list for possible value plays, the companies and their “since-IPO” returns are listed on the page.
What about getting into the IPO ETF with the fund sitting down at $30 per share? We wouldn’t recommend it—there are too many wildcards on the list. Some holdings do look promising going forward, however. Names like Palantir (PLTR), Snowflake (SNOW), Airbnb (ABNB), and DoorDash (DASH) have all seen their share prices pummeled, and these are companies which will still be around when the markets regain lost ground.
Tu, 27 Sep 2022
Food Products
Bucking the trend: Penn member General Mills has rallied 20% this year
Virtually all asset classes, sectors, and industries are in the red this year with the exception of energy stocks, and even they have been tumbling recently as crude oil has dropped back to where it began the year—the mid-$70s-per-barrel range. One consumer defensive name has been bucking the trend, however: General Mills (GIS $79) has rallied 20% so far in 2022—hitting an all-time high price last Thursday—and is up some 34% over the past year. Not only did the century-old food products firm report higher-than-expected profits over the past quarter, management also lifted its forecast for the year. Sales in the fiscal first quarter, which ended 28 August, rose 4% (to $4.72B), while net income jumped 31% from the same period last year—to $820 million.
While inflation has raised input and shipping costs for General Mills, the company has been able to pass along some of those higher prices to a consumer which is suddenly eating out less and cooking more meals at home. The stellar management team, led by 55-year-old Jeff Harmening, has also been making some astute strategic moves recently. In an effort to focus on more profitable units, the company recently sold its “Helper” line and Suddenly Salad packaged food division for $607 million, while acquiring St. Louis-based TNT Crust for $253 million. While consumers have been shifting away from higher-priced labels in favor of generic brands, General Mills products remain in the sweet spot. Harmening’s team also placed some well-timed hedge positions on grain inputs, cushioning the blow of rising agriculture prices. For the fiscal year, the company expects to grow net sales by 6-7%.
One of our favorite moves General Mills made a few years ago was the purchase of the rapidly growing Blue Buffalo line of pet foods. In fact, that was a catalyst for our purchase of GIS shares back in 2018. The company is the only packaged food name within the Penn Global Leaders Club.
Fr, 23 Sep 2022
Market Pulse
Another bruiser: markets have now given up two full years of gains
For the past two weeks in particular, the markets have had a myopic fixation on what the Fed’s next moves will be. The Tuesday before last, the Dow Jones Industrial Average lost 1,276 points after a hot August inflation read all but guaranteed a three-quarter-point rate hike in September. This Wednesday, when the Fed delivered, it dropped another 522 points. With the NASDAQ and Russell (small caps) leading the retreat, the major indexes all dropped around 10% over the past ten trading sessions, falling back to October of 2020 levels. So much for the June lows—those were taken out Friday intraday before bouncing slightly. It wasn’t only the Fed, though that was the big catalyst. The other concern markets seem to be stewing about is the strong US dollar, which is at its highest level in precisely two decades. That makes imports and overseas travel cheaper for Americans, but our exports more expensive for the world. But the strong dollar shouldn’t affect US small-cap companies much, as most rely on the domestic marketplace for the lion’s share of their revenues. It has been a brutal year thus far, but if our economy cannot handle a dollar at parity with the euro and a potential 5% federal funds rate, then that is a sad testament to American exceptionalism.
In reality, the US economy can and will be able to deal with these two conditions—a strong dollar and higher rates; it is investors who seem unable to come to terms with the situation. Great American companies, flush with cash and on strong growth trajectories, have not been spared during this latest selloff, which makes little sense. Until the madness abates, we are taking advantage of the dislocation in short-term rates by buying Treasuries, agencies, and quality corporate bonds.
Fr, 23 Sep 2022
Transportation Infrastructure
FedEx shares just suffered their worst day ever; are they now worth looking at?
When FedEx (FDX $148) shares were trading at $245.63 this past February, we removed the company from the Penn Global Leaders Club to make room for another holding. We had lost a good degree of confidence in the management team, and labor costs were suddenly becoming a major drag on the firm. That move was fortuitous, as FedEx just experienced its worst day as a publicly traded company—losing nearly one-quarter of its market cap—after a disastrous earnings call. After giving a rosy outlook in June, management did a 180-degree turn in September, reducing guidance by 50% and predicting a bruising global recession. Analysts were quick to point out that the major issues were not macro in nature, but directly related to this integrated freight and logistics giant. Q1 earnings per share fell 21% from the year prior, against expectations for an 18% gain; revenues rose 5%, but that number missed estimates as well. The company pulled its 2023 guidance altogether, citing a gloomy and uncertain global outlook. To round out the ugly report, FedEx said it plans to raise shipping rates this coming January by an average of 6.9% across the board. Shares are now down over 42% year to date.
With shares trading where they were back in June of 2020, are they now a buy? While the $2.7 billion in cost-cutting measures will help, and customers will probably just accept the shipping rate hikes, we don’t see the shares worth much more than $200 right now; and the risk to get that possible 33% return is still too high in our opinion.
Fr, 23 Sep 2022
Monetary Policy
Powell’s words left little doubt: rate hikes until inflation is under control
For anyone who still believes the stock market is rational and efficient, consider this: Going into the Fed’s rate decision, the Dow was trading up a few hundred points; within seconds of the fully-expected 75-basis-point rate hike, the Dow was down a few hundred points; during Powell’s post-decision speech, the Dow rallied into the green by several hundred points, only to close the session down 522 points.
No matter how late investors or pundits may believe Powell was to the party, his message has been crystal clear: Rates will go up until inflation is brought down to acceptable levels. While the official “acceptable” level is 2%, he said something very telling in his news conference: “The ultimate goal is to have positive real rates across the yield curve.” To us, that was meaningful. By “real rates” he means inflation adjusted, so if the 2-year Treasury is yielding 4% then inflation must be below that. They say markets don’t like uncertainty; well, we now have full clarity with respect to what the Fed plans on doing next.
Of course, we still don’t know how many rate hikes and other shocks to the system it will take to tame inflation. Furthermore, it will take time for the hikes to have their full effect on economic conditions as Fed actions typically have a lot of lag. The central bank forecasts a funds rate of 4.4% by the end of the year, which would point to one more 75-bps hike in November (there is no October meeting) plus a 50-bps hike in December. From there, we may see a few quarter-point hikes before the Fed pauses. We thought it would take a lot to get the fed funds rate to 4%; odds are now in favor of a 5% terminal point. That’s high, but not disastrous for the economy. For historical perspective, we were sitting at a 6.5% rate in August of 2000 and a 5.25% rate in May of 2008. Despite the market tantrums, the economy will weather these rates just fine.
A combination of two catalysts will fuel the coming market rally: signs that inflation is finally coming down, and the Fed’s indication that a pause in hikes is near. We see both of these indicators appearing within the next four months. In the meantime, own quality equities and load up on fat-yielding, shorter-maturity bonds.
Mo, 19 Sep 2022
Fixed Income Desk
The sudden and unusual opportunity in short-term bonds
Every now and again, bizarre things happen in the bond market which provide unique opportunities for investors. When we buy fixed income vehicles, from CDs to Treasuries to corporate bonds, we expect to get a higher yield for taking on the risk of going further out on the time horizon—assuming parity with respect to issuer safety, of course. For example, we expect a 30-year Treasury bond to have a higher yield than a 10-year Treasury note, and that 10-year should be paying more than a 2-year issue. The benchmark spread is the difference between the 10-year and 2-year yield. When the shorter maturity issue has a higher yield than its longer-maturity counterpart, we get a condition known as a yield curve inversion—generally a sign that a recession is on the way.
Right now, we have a quite rare situation: the 2-year Treasury carries a yield higher than all of the longer-maturity issues. Since the 2-year is considered a proxy for what the Fed will do next and the 30-year gauges investor sentiment about the economy, all bets are now on rates continuing to rise until the Fed hits a wall and is forced to pivot. Considering money markets are still yielding close to nothing, and bond values have been dropping in investors’ portfolios, now is a golden opportunity to pick up higher-yielding bonds with shorter maturities and low duration (duration measures sensitivity to changes in the interest rate).
And this opportunity is not limited to government-issued securities. While the 2-year Treasury is currently yielding just shy of 4%, corporate issuers are forced to offer even higher rates (either through new issues or thanks to discounted prices on current bonds in the secondary market) to compete with the risk-free nature of vehicles backed by the full faith and credit of the US government. It has been hard to get excited about bonds for some time; right now, at least with respect to the lower end of the ladder, that is not the case. Investors should strike before conditions change.
We are loading up on low-duration bonds issued by quality companies to take advantage of current conditions. Even bank-issued CDs with maturities of two years are offering rates around 4%. Due to the unique challenges facing Europe and Asia right now, we are sticking primarily to debt issued by domestic firms and financial institutions.
Tu, 13 Sep 2022
Government Watchdog
California dreaming: burger flippers could soon have a $22 per hour minimum wage
On Labor Day, fittingly, California Governor Gavin Newsom signed a stunningly egregious law into effect. While its official name is the Fast Food Accountability and Standards Recovery Act, that is about as accurate as calling a trillion dollar spending bill an Inflation Reduction Act. We have a more accurate name we would like to propose: The $22 Per Hour Minimum Wage Act for Burger Flippers. There are no cutesy acronyms politicians are so fond of, but it clearly spells out the intent.
The law will create a Fast Food Council in Cali, made up of a 10-person cabal of workers, state officials, and management—the latter to make it look credible. This cabal will set the “living wage” for fast-food workers employed at companies which operate at least 100 locations around the country (not the state). Clearly, the target is McDonald’s, Chick-fil-A (the one they really hate), Burger King, Chipotle, and a number of other “fat cats.” The ruling council will have the power to create a new $22 per hour minimum wage for all fast-food workers, beginning next year. The law was strongly supported by the Service Employees International Union, which has been advocating a nationwide, $15 per hour minimum wage. Since California is already set to raise the minimum wage to $15.50 per hour in 2023, we suppose $22 would be the next common sense target.
Of course, there is nothing common sense about this act or the politburo-like body it has created. Two unintended consequences immediately come to mind: $15 hamburgers and a more automated workforce. One will punish consumers who are already reeling from runaway inflation, and the other will punish the very workers who are supposed to be helped by this act. From California, which had attempted to place a cancer warning on every of coffee sold, this move is par for the course. We just can’t understand why so many companies are heading for the exits.
The brilliance of our Founding Fathers in giving so much power to the states (rather than a central government) is once again on full display. Newsom can deny the fact that companies are fleeing his hammer and sickle mentality, and the Chicago mayor can proclaim that the city’s economy has never been stronger, but the evidence proves otherwise. Maybe the voters who keep them in power will see the light one of these days. But we doubt it.
Tu, 13 Sep 2022
Economics: Supply, Demand, & Prices
A hot August CPI report gives the Fed the green light for another 75-bps hike
The seemingly major contingent of investors who believe the Fed is on the cusp of pivoting—moving from rate hikes to a pause to potential rate cuts due to an economic slowdown—befuddles us. In what realm are they living? What metrics possibly back up such a pivot? It is nonsense. With this contingent in mind, it really shouldn’t come as a surprise that Dow futures swung some 700 points, from up over 200 to down over 500, on the back of a higher-than-expected August inflation report. The consumer price index, or CPI, which tracks the price of a large basket of goods and services, rose 8.3% from last year—despite the sharp decline in gas prices for the month. Food, shelter, and medical care costs drove the spike in prices, while the average price for a gallon of gas fell 10.6%. A couple examples of food inflation: eggs are up 40% from last year, while bread is up over 16%. In the auto space, the average price of a new vehicle rose by 0.8% for the month, or 10% annualized. Medical care costs have risen 5.6% from the same period last year. The two-year Treasury note, a proxy for what the Fed might do next, surged from 3.358% to 3.704%, driving bond values down. We have been expecting the Fed to raise rates by 75 basis points at this month’s FOMC meeting; this report all but guarantees that taking place.
The August CPI report and subsequent market drop created a great opportunity for investors. The responsible behavior of the Fed will ultimately lead to a reduction in the rate of inflation, a healthier economy, and a stronger stock market. And it won’t take long for that theory to play out. The closer the Fed gets to 4%, the closer a major rally is to manifesting.
Mo, 12 Sep 2022
Economics: Housing
Mortgage rates hit highest level since 2008
This past week, the average interest rate for a 30-year mortgage did something it hasn’t done since November of 2008: hit the 6% mark. Considering rates topped out about three times that level back in the 1980s, the current rate may not seem too daunting, but that figure reflects a 130% spike from just over two years ago. As the Fed works to get inflation under control, this is certainly one of the intended consequences of the tightening cycle. As mortgage rates rise, it should cool the housing market and, hence, runaway home prices. Unfortunately for would-be buyers, that has not happened, leaving them at the mercy of higher rates and higher prices. For those putting their homebuying plans on hold, there is another problem: rents are rising just as fast. We did a double take when we saw this figure, but the national average for renting a single-family home in the US rose 13.4% from 2021 to 2022, to $2,495 per month. For apartment dwellers the picture is nearly as bad: the monthly rent for a multifamily dwelling in the US rose 12.6% from July of 2021 to this past July, to $1,717. And occupancy rates remain high for rental housing, hovering around 96%. It may seem warped, but this is precisely why the Fed must continue to raise rates. Ultimately, something must put downward pressure on home prices.
It may seem counterintuitive to look at buying the homebuilders now, but their prices have been so beaten down by the fear of rate hikes and a coming recession that they are beginning to look very attractive. While the builders of lower-end homes will face more difficulty, names like Toll Brothers (TOLL $45) and D.R. Horton (DHI $74, Emerald Homes is its luxury division) look attractive. Both companies have ultra-low P/E ratios—both current and forward—in the 4-6 range, and both have plenty of cash on hand to weather any coming housing storm.
Th, 08 Sep 2022
Global Strategy: Europe
Despite severe recession risks, the European Central Bank raises rates 75 bps
Typically, in the face of a potentially severe economic downturn, a country’s (or region’s) central bank will begin lowering interest rates in response. In an illustration of just how wrongheaded the ECB’s decision was to go negative with interest rates back in 2014, Europe’s central bank has been forced to do just the opposite: raise rates. It began back in July, when the ECB raised its deposit facility interest rate from -0.5% to 0.00%—a 50-basis-point hike. Now, due to runaway inflation (primarily caused by the energy crisis), the bank has been forced to match the Fed’s most recent action and raise rates another 75 basis points, to 0.75%. In addition to putting downward pressure on inflation, this move should also shore up the euro, which recently dipped to parity with the strengthening US dollar.
The irony of the ECB’s needed move is that the European Union is simultaneously pumping hundreds of billions of euros into the economy to help families deal with skyrocketing energy costs. Basic economics says that when a central government pumps money into an economy, inflation naturally increases. Eurozone inflation rose to 9.1% in August and is expected to hit double digits in September. The ECB, like the Fed, has an inflation target rate of 2%. It has a long way to go before getting anywhere near that number, unless a severe recession grinds the European economy to a halt.
It has been a full decade now since the key European rate has been above zero. ECB President Christine Lagarde, meanwhile, has signaled more hikes to come. These hikes are needed, but they will only increase the likelihood of a deep recession hitting the continent this winter.
Fr, 02 Sep 2022
Economics: Work & Pay
Two key positive takeaways from the August jobs report: unemployment and labor force participation
Here was the conventional thinking as investors awaited the August jobs numbers: if the report was strong, the Fed would continue hiking rates and stocks would be punished; if the report was weak, the Fed might start tapping on the brakes and stocks would celebrate. We ended up with something in the middle, and that was the best possible outcome.
First the headline number. There were 315,000 new nonfarm jobs added in the month of August, or slightly fewer than the 318,000 expected. Wages rose 5.2% from a year ago—not a positive sign for inflation, but not as much as expected. There were two key components of the report that helped turn futures from flat to positive. The first was the unemployment rate, which surprised analysts by ticking up from 3.5% to 3.7%. The second was the reason for that jump: the labor force participation rate rose an impressive 0.3%, to 62.4%. That may not seem like much, but it meant another 800,000 Americans began looking for work.
One of the biggest causes of inflation has been the scarcity of workers, forcing employers to pay more to attract new help. That pool of workers just got a lot bigger, which should help dampen the recent wage spikes. The prime-age labor force participation rate—workers between 25 and 54—surged to 82.8%, which is great news on that front. Overall, it is hard to imagine a much better report rolling in right now.
We still want—and expect—to see a 75-basis-point rate hike coming in September, which would bring the upper band of the Fed funds rate up to 3.25%. We still need to see any combination in subsequent months pushing that rate up to 4%. Then, it will be time to pause until inflation moves back down to an acceptable level. The Fed will also be reducing its $9 trillion balance sheet over the coming year. To be clear, this scenario is what needs to happen, not what the market wants to see.
Mo, 29 Aug 2022
Industrial Conglomerates
3M wanted bankruptcy court for one of its subsidiaries; a judge denied the request
Between 2003 and 2015 a 3M (MMM $126) subsidiary by the name of Aearo Technologies manufactured and supplied earplugs to the United States military for troop training and for troops stationed in a combat environment. Production of the earplugs, which were unique in their two-sided design, ceased in 2015. In 2016, a competitor filed a whistleblower lawsuit claiming that 3M knew the plugs were defective, causing hearing loss and tinnitus in scores of soldiers. Two years later, the company agreed to pay over $9 million in a victims’ fund. After that tiny amount was paid, some 230,000 service members began filing lawsuits against the firm; the suits were ultimately consolidated through multidistrict litigation (MDL, somewhat akin to a class action lawsuit but more personalized) and handed off to a bankruptcy court in the Northern District of Florida.
In an effort to limit its own liability, 3M declared bankruptcy for its Aearo Technologies unit and threw a gauntlet down to the judge, arguing that it was not within his power to interfere with the proceedings. The judge did not share that opinion. Shares of the company plunged nearly 10% after Judge Jeffrey Graham denied 3M’s attempt to offload the company’s problems in such a manner, keeping the parent company on the hook for a potentially enormous payout. While the cases which have already gone to trial present a mixed picture, it is easy to imagine the ultimate payout to a large percentage of 230,000 plaintiffs dwarfing the $1 billion amount the company has since set aside for settlement. For example, in ten cases which have already been decided, five were won and five were lost by the company, with the successful plaintiffs being awarded between $1.7 million and $22 million each. Here’s a staggering fact to consider: If one out of every three plaintiffs in the case were awarded $1 million, the dollar amount would be roughly equivalent to 3M’s market cap.
Over the course of the past nine years, 3M shares are flat. They were trading at $126 back in 2013, and they trade at $126 right now. The company is trying to pull a General Electric (GE $76) move by spinning off its healthcare business (the current GE shouldn't be used as a model for anything, except what not to do), arguing that long-term shareholder value will be created. We don’t buy it. As for the stock, we offer the same recommendation—don’t buy it.
Fr, 26 Aug 2022
Market Week in Review
There are well-founded market drops, and then there are the type that happened Friday
Did investors really believe Jerome Powell was about to pivot and become a dove? Perhaps they were expecting him to come out in front of the gorgeous mountain range at Jackson Hole and proclaim, “Inflation is no longer a threat or a problem, we must get rates back to zero!” Complete silliness. Instead, he did what everyone should have fully expected: In front of some wood paneling straight out of the ‘70s (fitting), he said that the Fed will continue to do everything it must to tame inflation. It was short and sweet…and correct. For us, that means the terminal Fed funds rate will be at least 3.5%, but we are hoping for 4%. If the markets can’t handle a 4% rate, then we have really dumbed down our economy.
Think of the trillions of dollars pumped into the economy by the Fed and the US Congress over the past few years. Does anyone other than a full-blooded, card-carrying Keynesian believe that is healthy for a country, an economy, the stock market, or individuals? No! Sure, we had to take extraordinary steps in response to the pandemic from China, but did it need to continue for two years? Furthermore, what about the $23 trillion worth of debt the government had built up before it added $7 trillion more post pandemic?
The market should have cheered a responsible Fed Chair following in Alan Greenspan’s footsteps and telling us he will do whatever it takes to staunch inflation. Instead, the Dow lost 1,008 points on the session, or 3%. In fact, all four major benchmarks (to include the Russell 2000) lost over 3%. Something to worry about? We believe just the opposite. Investors are myopic. Powell gave then exactly what they needed (a responsible policy), not what they wanted (a shiny early Christmas present), and after the temper tantrum we will be back on the upswing. Friday wasn’t a day to worry; it was a day to identify strong companies which have been senselessly beaten down.
Th, 25 Aug 2022
Global Strategy: Europe
Europeans face a harsh winter thanks to skyrocketing energy prices
Americans have certainly noticed their energy bills rising this year, and the problem will be exacerbated this winter when most households switch from their electricity-powered a/c to natural gas-powered heating systems. In fact, one in six American households now have overdue utility bills—the largest percentage on record. But Americans’ problem is nothing compared to that of their European counterparts, who now face an astronomical spike in energy prices.
The long-term average price in US dollars for one million British thermal units (MMBtu) of natural gas imported into Europe is $4.20. Today, that figure has skyrocketed some 718%—to $34.35—from its average. Electricity rates in Germany are now six times higher than they were last year, while the French are facing €900/megawatt-hour energy prices—ten times the cost as last year. France’s issue has been magnified due to its nuclear energy problems—over half of the country’s reactors are offline due to maintenance, repair needs, or river issues (reactors need massive amounts of river water for cooling; water levels are low right now, and temperatures are unusually high). While governments grapple with how to best help their citizenry with out-of-control prices, there are no easy answers. The long, hot summer in Europe will morph into a frigid and painful winter, much to Putin’s delight.
We have been underweighting both developed and emerging markets in Europe due to a host of economic issues. First and foremost is the continent’s massive energy crisis; a problem which came about due to an overreliance on Russia for its needs. Perhaps France and Germany will learn from this, but it will take years for the problem to be resolved.
Th, 25 Aug 2022
Specialty Retail
“Diamond hands” traders just got screwed over by mentor on Bed Bath & Beyond
By now, we all know who and what “diamond hand” traders are: people who follow social media sites like r/wallstreetbets, buy the flailing companies touted in an effort to crush short sellers, and then hang onto the shares no matter what. One of their recent champions has been Ryan Cohen, the activist investor who took a major stake in Bed Bath & Beyond (BBBY $10) back in March through his RC Ventures hedge fund. Shares of the home retailer rocketed from $15 to $30 as diamond hands piled in. Subsequently, however, as it became clear just how bad the financials were for the company, negative headlines and downgrades pushed the shares down to the $4 range. Cohen was sitting on a huge loss (he owned about 10% of the shares at that point). His firm then purchased call options on nearly 1.7 million shares of BBBY, driving the price back up to the $30 range. Then, Cohen did what no self-respecting diamond hands trader would do: he sold his entire position. This caused the shares to tumble 52% over the course of two days, leaving the hedge fund manager with a $68 million profit and his followers with enormous unrealized losses. Cohen’s investment firm had no comment.
Will Cohen’s actions at BBBY make many meme stock traders reconsider their “strategy?” Probably not. For investors who are serious about their portfolios, however, this story buttresses an important tenet: Understand the companies you are buying, what their unique value proposition is, and whether or not they will have the financial wherewithal to navigate any economic environment. And never have diamond hands—never hesitate to take profits and minimize losses.
Tu, 23 Aug 2022
National Debt & Deficit
Your government spent $2.775 trillion more than it collected last year
If we talk about enormous sums of money too often the brain begins to accept them; or, at least, gloss over them. That is not good. We need to understand the fiscal irresponsibility of our elected officials to have any hope of changing their actions. So, instead of simply saying that this country is currently $30.7 trillion in debt, let’s try this fact: If each US taxpayer were directly responsible for their portion of America’s debt, we would owe $244,315 apiece. Want to add your kids and other non-taxpayers into the mix? In that case, every US citizen owes $92,272.
Keeping in mind that 2020—not 2021—was the year we bore the brunt of the pandemic from an economic standpoint, consider how much the US government collected and spent last year. Revenue collected came in at $4.045 trillion. Last year the government spent $6.820 trillion. The difference, or deficit, is how much we grew the national debt last year: $2.775 trillion. At the risk of being redundant, our government spent $2.775 trillion more than it took in last year, in the midst of a rip-roaring economy. What is even more disgusting is that Social Security inflows and outflows are wantonly thrown into the mix rather than being physically separated, as they should have been from the start, from the general funds. Were your company to do that with your 401(k) plan, it would be a criminal act.
Understandably, the largest deficit on record took place in 2020. There is no excuse, however, for 2021’s budget-busting numbers. And as interest rates rise, it is going to take a bigger and bigger portion of revenue to simply service the interest on the national debt each year. Right now, a “paltry” ten cents out of every dollar collected goes toward interest payments. Imagine ten cents out of every dollar you earn going towards the interest on your credit card debt! Madness.
There are two ways this slow-moving (actually, not-so-slow-moving) train wreck can be avoided: the positive way via a balanced budget amendment and term limits added to the US Constitution, or the negative way through a fiscal meltdown. The fallout from the latter is hard to fathom.
Mo, 22 Aug 2022
Work & Pay
A wave of layoffs are probably coming soon; how will that affect unionization efforts?
Consulting firm PwC polled over 700 executives from US firms in all industries and of all sizes, and they found that over half plan to reduce headcount and implement hiring freezes within the coming months. While it may seem counterintuitive, many also said they plan on simultaneously increasing their number of contract workers and freelancers. Dig a bit deeper, however, and that makes perfect sense. With a slowing economy, higher inflation, and supply chain issues, many firms suddenly find themselves dealing with a renewed unionization push. And this time around, it is not just industrial names which are in the crosshairs. Consumer discretionary companies like Starbucks (SBUX $87), which are known for their generous benefits like tuition assistance, are bearing the brunt of the push. That is illogical, and we fully expect the inevitable increase in the 3.5% unemployment rate to help quell the movement.
Technology will also play a role in dampening successful activism, as advances allow firms to be more productive with a smaller headcount. A McDonald’s (MCD $266) restaurant, for example, might add new ordering kiosks, while an Apple (AAPL $169) might reduce its physical footprint in favor of an enhanced online presence. This is not the 1970s: Companies now have levers to pull in order to maintain their productivity levels—tools which were simply not available back then.
Speaking of productivity, it has been going down recently for the first time in a long time, and new studies are indicating that work-from-home is playing a role in the drop. This is one of the reasons why companies such as Apple are now demanding their workers return to the office at least two or three days per week. Right now, that mandate is limited to the area around Apple’s Cupertino headquarters, but we expect the requirement to expand into other areas soon. The back-to-work request has been a hard one to enforce with the low unemployment rate, but now that stimulus funds are depleted—and as the unemployment rate rises—expect more of these policies to come down the pike. We imagine a large percentage of those 700 executives will be watching Apple’s initiative with interest.
There is a natural ebb and flow to the unionization movement in America, with undercurrents such as the political environment and economics (the unemployment rate) affecting the efforts. Right now, corporations appear to be up against the ropes, but time and technology are on their side. This is especially true for the companies who treat their employees as fellow stakeholders rather than simply a line on a balance sheet.
Tu, 16 Aug 2022
Food & Staples Retailing
Walmart shares pop 5% after the company tops estimates and sticks to full-year guidance
It was just under a month ago that Walmart (WMT $140) shares plunged following dire management warnings on crimped profit margins due to inflation and a consumer who was cutting back on discretionary spending. The shock waves from those comments were felt throughout the industry. This week, we received a different story line. Walmart shares gained over 5% on Tuesday’s open following a revenue beat ($153B vs exp. $151B), an earnings beat ($1.77EPS vs exp. $1.63), and an improved outlook for the full year. Same-store sales at its flagship stores rose 6.5% in the quarter, while Sam’s Club saw a 9.5% gain. CEO Doug McMillon said that the company is now effectively working through the inventory problems which were at the heart of July’s lowered guidance. McMillon also said that behavior changes due to inflation are driving higher-income households into Walmart stores. Whatever the reason, the Street remain generally bullish on the company: out of 39 analysts, 20 have a buy rating and none have an underperform or sell rating on the shares.
Walmart is one of the 40 companies within the Penn Global Leaders Club.
Tu, 16 Aug 2022
Global Strategy: East/Southeast Asia
China cuts rates as economy slowing on nearly all fronts
Consider this: The US economy is slowing and layoffs are increasing, but the Fed remains committed (correctly so) to rate hikes; the European Union faces an even more severe economic slowdown and a brutal coming winter due to a Russian-fomented energy crisis, and the ECB is raising rates; China’s economic growth rate is slowing on nearly all fronts, and the People’s Bank of China just cut rates. That unexpected action by China’s central bank highlights the dichotomy between how the West and the East are dealing with an unwelcome mix of high inflation and probable recession.
While China didn’t cut its interest rates by much (the main rate at which it provides liquidity to banks dropped from 2.1% to 2%), the government simultaneously announced it was pumping an additional $60 billion into its financial system to spur lending. The challenge with both of those moves is the fact that Chinese citizens are very reluctant to borrow right now due to angst over lockdowns, an economic slowdown, and a nightmarish real estate market. (The government is placing strict controls over the sale of properties by homeowners, adding to the apprehensiveness of would-be buyers.) For a communist party which bases its very existence on control, the inability to get its people to act in a certain way must be maddening.
As for the economic slowdown in the country, economists are rushing to downgrade expected rates of growth. TD Securities, for example, just lowered its full-year GDP expectations to 2.9%, while UBS admitted to seeing “downside risks” to its 3% full-year growth forecast. Unlike the American consumer, which has been full steam ahead, Chinese consumers have purchased around half of the retail goods economists had expected by this point in the year. And there are scant indications that the situation will get better anytime soon.
Of course, US retailers who became overly reliant on Chinese sales will also be hurt by the country’s economic slowdown. That fact, combined with the strong US dollar, should have investors searching for small- and mid-cap consumer cyclicals which receive the lion’s share of their revenues from domestic sales.
Mo, 15 Aug 2022
Media & Entertainment
Clown company: You couldn’t give us shares of Getty Images Holdings
How fitting that Getty Images Holdings (GETY $31) went public via a SPAC—it certainly would have been a humorous roadshow full of fanciful tales of projected growth had they been forced to use the traditional process. It is also fitting—and sad—that “investors” pumped the value of the shares up from $10 to $31 since this joke of a company went public late last month. Getty, whose shares are worth—in our opinion—about $1 apiece, now has a market cap of $11 billion. Do people literally have money to burn?
As the name implies, Getty Images sells stock images to creative professionals, the media, and corporations. Protecting copyright infringement is serious business, but Getty has turned it into a nefarious source of revenue. Examples of the firm’s abuse of power are too numerous to mention, but here is a rather typical scenario: A photographer uses one of their own digital photographs on a website. Not long after, the photographer receives a demand of payment from Getty for using the photograph; the demand comes with a threat of legal action unless the confiscatory amount requested is paid immediately. The photographer takes legal action to get the threats stopped, as they created the very image in question! The company also uses embedded technology within images to “go fishing” for people who might use the images, thus initiating the demands for payment.
The last thing Getty wants is for people to call their bluff and demand that a court decide an outcome—the company has lost a string of cases, drawing rebukes from the courts. Getty also has a well-documented history of taking images in the public domain (“free use”) and leasing them to unsuspecting customers for up to $5,000 for a six-month term.
For any investors believing they will own a piece of a growing enterprise, consider the fact that this is not the first time Getty has been publicly traded, and that only twelve shareholders own nearly 80% of the company. It may be legal, but it is a scam in our books.
Getty is the sort of company that would love to sue anyone with a disparaging view of their operations. The New York Stock Exchange should have steered clear of this listing, and investors should run the other way.
Th, 11 Aug 2022
Economics: Supply, Demand, & Prices
At long last, the steep inflation trajectory is beginning to moderate
Within seconds of the report’s release, Dow futures soared more than 400 points—led by consumer discretionary names. Finally, after months of ever-growing rates, inflation cooled in July. Following June’s 9.06% YoY rate and 1.32% MoM rate, and against expectations for an 8.7% annual increase, the price of goods and services in the US rose by “only” 8.5% in July. The MoM number, which was expected to rise by 0.2%, actually fell by that precise amount. While the 7.7% drop in gas prices in July helped drive that number down, even when energy and food prices are excluded core CPI still rose less than expected: 5.9% versus the 6.1% expected. Housing costs, which make up around one-third of the CPI, rose 5.7% from a year ago.
The report brought a sigh of relief to investors, as the Fed has indicated it will continue raising rates until it tames inflation. Any number above consensus would have increased the odds for an even greater rate hike at the September FOMC meeting. Another 75-basis-point hike is still expected, followed by two or three smaller hikes before the end of 2022. Buttressing the good news on the consumer side of the inflation front, the producer price index (PPI)—a reflection of what producers of goods and services must pay—also fell in July. Instead of the expected 0.2% jump MoM, prices actually fell 0.5% from June.
One month does not a trend make, but we believe peak inflation is now behind us. Now, the move downward must be gradual enough so as to not create a more dovish Fed before rates get back up to where they should be. We need decent bond yields in order to build well-balanced portfolios.
We, 10 Aug 2022
Consumer Electronics
Amazon is buying iRobot for $1.7 billion
We were early investors in consumer robot company iRobot (IRBT $59), initially buying shares of the company shortly after they went public. It has been a wild, seventeen-year ride for those shares, coming out of the gate around $24, rising all the way to $197.40 in the spring of 2021, and then falling back to $35.41 a few months ago. We actually took our profits around $65 per share (we owned the company in the Penn New Frontier Fund) when a stop loss hit. Now, the maker of those cute little Roomba autonomous vacuums, Braava robot mops, and (coming soon to a backyard near you) Terra robot mowers is being acquired by Penn member Amazon (AMZN $138) for $1.7 billion in cash—around $61 per share. We love the deal.
Amazon’s Alexa already supports iRobot devices (“Alexa, ask Roomba to start vacuuming”), and now the enormous, $1.4 trillion e-commerce company can provide the needed cash inflow for the development of new devices. iRobot has faced a number of headwinds lately, to include tariffs (it is now moving a large portion of its manufacturing operations from China to Malaysia), rising input costs, supply chain issues, and an unanticipated drop in demand due to deteriorating global economic conditions. While the firm has generally operated in the black over the past decade, Amazon’s deep pockets will assure the company is able to weather a recession and come out stronger during the next recovery phase. The deal is expected to be completed by the end of the year.
Talk about a great marketing platform for iRobot: being highlighted by the world’s largest e-commerce company should provide a great catalyst for future sales. As for Amazon, it remains one of our highest-conviction holdings. We added to the position following the stock split (when shares were trading around $100) and have a price target of $200 on the shares. Amazon is one of the 40 holdings within the Penn Global Leaders Club.
Fr, 05 Aug 2022
Market Pulse
At first, the market hated the
Th, 28 Jul 2022
Airlines & Air Freight
Shocker: Spirit terminates Frontier bid, agrees to JetBlue merger
We have written about the ongoing saga between three small-cap airlines, Spirit (SAVE $25), Frontier (ULCC $11), and JetBlue (JBLU $9), each approximately $2.5 billion in size, for the past several months. Despite JetBlue’s hostile takeover push for Spirit, it looked as though a Spirit/Frontier merger was as good as done. In fact, two major shareholder advisory firms were recommending that the deal be approved. The CEO of Spirit, Ted Christie, had argued that the Federal Trade Commission and the Department of Justice would never approve a merger with JetBlue. Suddenly, in a rather shocking reversal, Spirit announced that it was terminating its deal with Frontier—scheduled to be voted on within weeks—and embracing JetBlue’s offer. Something stinks. We will never know what went on behind closed doors, but it would probably be worthy of a book. JetBlue, it should be noted, has the worst on-time record in the industry, with nearly 10,000 canceled or delayed flights (39%!) in the month of June alone. The deal would give Spirit shareholders $33.50 per share in cash, an aggregate equity value of $3.8 billion, and carry with it a breakup fee of $400 million if it is shot down by regulators.
There is a lot of baggage to unpack here. First and foremost, we believe the feds will not approve the merger on anticompetitive grounds. Beyond that, what happens to Frontier, our personal favorite of the three, now that they are left to fend for themselves in an industry dominated by the four large players—United, American, Delta, and Southwest? And what magic panacea will allow JetBlue to improve its horrendous on-time record? Our advice? Don’t touch any of the low-cost carriers. And avoid flying JetBlue.
We, 27 Jul 2022
E-Commerce
Shopify drops another 14% after booting one-tenth of its workforce out the door
At one time we were intrigued with Canadian e-commerce platform Shopify (SHOP $32); now, we find ourselves repelled by the firm. Back in spring, we wrote of two big decisions by the board: the initiation of a ten-for-one stock split, and the creation of a new share class (the Founder share) which would increase CEO Tobi Lutke’s voting power to 40%. Why not just decree him ruler for life? That was an outrageous move, made even more distasteful by the company’s decision on Tuesday to boot 10% of the workforce out the door “by the end of the day.” Lutke admitted to misreading the strength of online shopping post pandemic, but words are cheap. The proper action would have been to join the 10% of fired workers and leave the building with his little brown shipping box.
Since the company’s ten-for-one stock split muddied the waters with respect to just how much the shares have fallen, consider this: In November of 2021 SHOP had a market cap of $212 billion; it is now worth $40 billion, or 81% smaller than it was nine months ago. We often talk about how the Nasdaq fell 78% between 2000 and 2002. Astonishingly, we now have a growing list of companies on that exchange which have dropped further than that in under a year. Certainly, some will come roaring back, but others will flounder for years. We can’t say in which camp Shopify will find itself, but we can say we wouldn’t invest in a firm where one person controls 40% of the voting rights.
Tu, 26 Jul 2022
Food & Staples Retailing
Walmart shares drop 8% after the retailer slashed its profit outlook
The good news: America’s largest retailer, Walmart (WMT $120), said it expects same store sales, ex-fuel, to rise 6% in Q2 over the same time period last year. The bad news: profit margins are being crushed by inflation and a pullback by consumers in discretionary spending. Put another way, the bottom 40% of wage earners, being harder hit by higher fuel costs and grocery bills, have little left over for apparel and other discretionary items. Unfortunately for Walmart, that is where the fattest profit margins reside. Although the retailer won’t formally report Q2 earnings until the 16th of August, management announced that an oversupply of merchandise (inventories rose some 33% in Q1) at both Walmart and its Sam’s Club locations was forcing it to cut prices, thereby reducing net income. The company is projecting an 8% to 9% decrease in EPS for the quarter, and an 11% to 13% drop in earnings for the full year.
Despite the move lower, Walmart is still holding up better than most of its peers. The company’s warning portends rough sailing ahead for lower-priced merchandisers which, unlike Walmart, do not have the luxury of relying on staples to help stabilize sales. Dick’s Sporting Goods (DKS $90), Kohls (KSS $27), and Bed Bath & Beyond (BBBY $5) all moved sharply lower after the announcement. Potential safety plays in the sector? We like well-run, dedicated grocers like The Kroger Company (KR $45) and Grocery Outlet (GO $44).
Mo, 25 Jul 2022
Metals & Mining
Newmont Mining just had its worst day since 2008
Despite gold’s recent drop, we remain quite bullish on the precious metal going forward. If we are in some time-warped 1970s redux, keep this in mind: Gold entered the 1970s around $40 per ounce and exited the decade around $500 per ounce; over that same time period, the Dow Jones Industrial Average grew from 800 to 839 (5%)! While not quite as bullish on the gold miners (due to a host of threats, from rising costs to geopolitical trouble around many of the world’s mines), we did see opportunity among the most well-run players.
On that note, we added Newmont Mining (NEM $44) to the Penn Global Leaders Club last year and it immediately began trading higher. Wishing to maintain our gains, we placed a stop on the shares. Fortunately, the stop price hit and the position was closed when Newmont shares dropped to a recent price of $60. Highlighting the importance of having protection in place on volatile holdings, the company just had its worst day since 2008, falling some 14% on the heels of the Q2 earnings release. While revenue remained steady YoY at $3.06 billion for the quarter, earnings per share (EPS) tumbled to $0.46 from $0.81 in the same quarter last year. Management reported a 23% increase in costs, to $932 per ounce mined. Furthermore, the company had an all-in sustaining cost of $1,150 per ounce due to inflationary pressures. While gold is off just over 5% thus far in 2022, Newmont finds itself down 27% year-to-date and nearly 50% below its April intraday high of $86.37.
Our three favorite gold mining stocks are all presently getting crushed. In addition to Newmont, shares of Barrick Gold Corp (GOLD) have dropped from $26 to $15, while shares of Kinross Gold Corp (KGC) have plunged from $7 to $3. While we are not ready to touch any of them right now, they should all see a nice rebound as costs return to normal. Of course, we can only speculate as to when that might be.
Mo, 25 Jul 2022
Aerospace & Defense
Boeing workers plan to strike; wait till you see what they deem as “inadequate”
(Update: Workers at the three Boeing plants in question approved a sweetened deal by the company, averting the strike) Pretty much every aspect of Boeing (BA $158) makes us uncomfortable right now. This critical American aerospace company, which never should have been allowed to knock out rival McDonnell Douglas, has a completely inept management team. The disgusting way in which two deadly 737-MAX crashes were handled is inexcusable. The chairman, who announced his wholehearted support for the former CEO right before the latter was fired, decided that he was the only person who could fix the company. Um, weren’t you the chairman of the board when the crashes occurred? Seemingly nothing is going right for the company, on either the aircraft or space side of the business. The company tells us that manned spaceflight is tough, and they can’t cut corners. Meanwhile, SpaceX is proving that the job isn’t too tough to get done. It is a Boeing problem.
Now, amidst all the self-inflicted problems at the firm, let’s throw in one for which we don’t really blame the company. Workers at three St. Louis plants, some 2,500 members of the machinists’ union, plan to go on strike in August. The tired old union arguments are really hard to swallow in this case—even more so than normal. They first feigned outrage that Boeing no longer has a pension plan. Who does these days?! They then complained about the “inadequate compensation” to the employees’ 401(k) retirement plans. This is where it gets comical. Right now, Boeing offers a 75% match on the first eight percent that a worker puts into his or her 401(k). Inadequate? That sounds like a gold-plated plan to us. But it gets better. In the negotiations, the company said it would increase the company match to dollar for dollar on the first ten percent. The response? A flat refusal, with the union stating that “the company continues to make billions of dollars each year off the backs of our hardworking members.”
Take a trip to nearly any corner of the world and read that statement to workers making a fraction of what Boeing workers make and gauge the response. As for the silly “billions of dollars” comment, the union had better check the company’s financials: Boeing lost $4.2 billion in 2021, $12 billion in 2020, and $636 million in 2019.
For the better part of 25 years Boeing was a staple holding for our clients. Now, until a complete board overhaul takes place, we couldn’t imagine owning the company. Sad. As we say, virtually every aspect of the company’s business model makes us uncomfortable right now.
Airlines & Air Freight
Shocker: Spirit terminates Frontier bid, agrees to JetBlue merger
We have written about the ongoing saga between three small-cap airlines, Spirit (SAVE $25), Frontier (ULCC $11), and JetBlue (JBLU $9), each approximately $2.5 billion in size, for the past several months. Despite JetBlue’s hostile takeover push for Spirit, it looked as though a Spirit/Frontier merger was as good as done. In fact, two major shareholder advisory firms were recommending that the deal be approved. The CEO of Spirit, Ted Christie, had argued that the Federal Trade Commission and the Department of Justice would never approve a merger with JetBlue. Suddenly, in a rather shocking reversal, Spirit announced that it was terminating its deal with Frontier—scheduled to be voted on within weeks—and embracing JetBlue’s offer. Something stinks. We will never know what went on behind closed doors, but it would probably be worthy of a book. JetBlue, it should be noted, has the worst on-time record in the industry, with nearly 10,000 canceled or delayed flights (39%!) in the month of June alone. The deal would give Spirit shareholders $33.50 per share in cash, an aggregate equity value of $3.8 billion, and carry with it a breakup fee of $400 million if it is shot down by regulators.
There is a lot of baggage to unpack here. First and foremost, we believe the feds will not approve the merger on anticompetitive grounds. Beyond that, what happens to Frontier, our personal favorite of the three, now that they are left to fend for themselves in an industry dominated by the four large players—United, American, Delta, and Southwest? And what magic panacea will allow JetBlue to improve its horrendous on-time record? Our advice? Don’t touch any of the low-cost carriers. And avoid flying JetBlue.
We, 27 Jul 2022
E-Commerce
Shopify drops another 14% after booting one-tenth of its workforce out the door
At one time we were intrigued with Canadian e-commerce platform Shopify (SHOP $32); now, we find ourselves repelled by the firm. Back in spring, we wrote of two big decisions by the board: the initiation of a ten-for-one stock split, and the creation of a new share class (the Founder share) which would increase CEO Tobi Lutke’s voting power to 40%. Why not just decree him ruler for life? That was an outrageous move, made even more distasteful by the company’s decision on Tuesday to boot 10% of the workforce out the door “by the end of the day.” Lutke admitted to misreading the strength of online shopping post pandemic, but words are cheap. The proper action would have been to join the 10% of fired workers and leave the building with his little brown shipping box.
Since the company’s ten-for-one stock split muddied the waters with respect to just how much the shares have fallen, consider this: In November of 2021 SHOP had a market cap of $212 billion; it is now worth $40 billion, or 81% smaller than it was nine months ago. We often talk about how the Nasdaq fell 78% between 2000 and 2002. Astonishingly, we now have a growing list of companies on that exchange which have dropped further than that in under a year. Certainly, some will come roaring back, but others will flounder for years. We can’t say in which camp Shopify will find itself, but we can say we wouldn’t invest in a firm where one person controls 40% of the voting rights.
Tu, 26 Jul 2022
Food & Staples Retailing
Walmart shares drop 8% after the retailer slashed its profit outlook
The good news: America’s largest retailer, Walmart (WMT $120), said it expects same store sales, ex-fuel, to rise 6% in Q2 over the same time period last year. The bad news: profit margins are being crushed by inflation and a pullback by consumers in discretionary spending. Put another way, the bottom 40% of wage earners, being harder hit by higher fuel costs and grocery bills, have little left over for apparel and other discretionary items. Unfortunately for Walmart, that is where the fattest profit margins reside. Although the retailer won’t formally report Q2 earnings until the 16th of August, management announced that an oversupply of merchandise (inventories rose some 33% in Q1) at both Walmart and its Sam’s Club locations was forcing it to cut prices, thereby reducing net income. The company is projecting an 8% to 9% decrease in EPS for the quarter, and an 11% to 13% drop in earnings for the full year.
Despite the move lower, Walmart is still holding up better than most of its peers. The company’s warning portends rough sailing ahead for lower-priced merchandisers which, unlike Walmart, do not have the luxury of relying on staples to help stabilize sales. Dick’s Sporting Goods (DKS $90), Kohls (KSS $27), and Bed Bath & Beyond (BBBY $5) all moved sharply lower after the announcement. Potential safety plays in the sector? We like well-run, dedicated grocers like The Kroger Company (KR $45) and Grocery Outlet (GO $44).
Mo, 25 Jul 2022
Metals & Mining
Newmont Mining just had its worst day since 2008
Despite gold’s recent drop, we remain quite bullish on the precious metal going forward. If we are in some time-warped 1970s redux, keep this in mind: Gold entered the 1970s around $40 per ounce and exited the decade around $500 per ounce; over that same time period, the Dow Jones Industrial Average grew from 800 to 839 (5%)! While not quite as bullish on the gold miners (due to a host of threats, from rising costs to geopolitical trouble around many of the world’s mines), we did see opportunity among the most well-run players.
On that note, we added Newmont Mining (NEM $44) to the Penn Global Leaders Club last year and it immediately began trading higher. Wishing to maintain our gains, we placed a stop on the shares. Fortunately, the stop price hit and the position was closed when Newmont shares dropped to a recent price of $60. Highlighting the importance of having protection in place on volatile holdings, the company just had its worst day since 2008, falling some 14% on the heels of the Q2 earnings release. While revenue remained steady YoY at $3.06 billion for the quarter, earnings per share (EPS) tumbled to $0.46 from $0.81 in the same quarter last year. Management reported a 23% increase in costs, to $932 per ounce mined. Furthermore, the company had an all-in sustaining cost of $1,150 per ounce due to inflationary pressures. While gold is off just over 5% thus far in 2022, Newmont finds itself down 27% year-to-date and nearly 50% below its April intraday high of $86.37.
Our three favorite gold mining stocks are all presently getting crushed. In addition to Newmont, shares of Barrick Gold Corp (GOLD) have dropped from $26 to $15, while shares of Kinross Gold Corp (KGC) have plunged from $7 to $3. While we are not ready to touch any of them right now, they should all see a nice rebound as costs return to normal. Of course, we can only speculate as to when that might be.
Mo, 25 Jul 2022
Aerospace & Defense
Boeing workers plan to strike; wait till you see what they deem as “inadequate”
(Update: Workers at the three Boeing plants in question approved a sweetened deal by the company, averting the strike) Pretty much every aspect of Boeing (BA $158) makes us uncomfortable right now. This critical American aerospace company, which never should have been allowed to knock out rival McDonnell Douglas, has a completely inept management team. The disgusting way in which two deadly 737-MAX crashes were handled is inexcusable. The chairman, who announced his wholehearted support for the former CEO right before the latter was fired, decided that he was the only person who could fix the company. Um, weren’t you the chairman of the board when the crashes occurred? Seemingly nothing is going right for the company, on either the aircraft or space side of the business. The company tells us that manned spaceflight is tough, and they can’t cut corners. Meanwhile, SpaceX is proving that the job isn’t too tough to get done. It is a Boeing problem.
Now, amidst all the self-inflicted problems at the firm, let’s throw in one for which we don’t really blame the company. Workers at three St. Louis plants, some 2,500 members of the machinists’ union, plan to go on strike in August. The tired old union arguments are really hard to swallow in this case—even more so than normal. They first feigned outrage that Boeing no longer has a pension plan. Who does these days?! They then complained about the “inadequate compensation” to the employees’ 401(k) retirement plans. This is where it gets comical. Right now, Boeing offers a 75% match on the first eight percent that a worker puts into his or her 401(k). Inadequate? That sounds like a gold-plated plan to us. But it gets better. In the negotiations, the company said it would increase the company match to dollar for dollar on the first ten percent. The response? A flat refusal, with the union stating that “the company continues to make billions of dollars each year off the backs of our hardworking members.”
Take a trip to nearly any corner of the world and read that statement to workers making a fraction of what Boeing workers make and gauge the response. As for the silly “billions of dollars” comment, the union had better check the company’s financials: Boeing lost $4.2 billion in 2021, $12 billion in 2020, and $636 million in 2019.
For the better part of 25 years Boeing was a staple holding for our clients. Now, until a complete board overhaul takes place, we couldn’t imagine owning the company. Sad. As we say, virtually every aspect of the company’s business model makes us uncomfortable right now.
Fr, 22 Jul 2022
Market Pulse
Despite Friday’s fizzled rally, all of the major benchmarks finished the week strong
Remember the chart of 1970’s wild S&P 500 ride we reviewed in the last issue of After Hours? Obviously, we are still very early in the second half of 2022, but our prediction of mirroring those results have been encouraging thus far. Friday’s shift from rally to fade wasn’t what we were hoping for to finish out a strong week, but it didn’t stop the S&P 500 from posting a 2.56% gain for the five sessions, surpassed only by the Nasdaq (+3.34%) and the small-cap Russell 2000 (+3.61%). There were two classes we wanted to see drop, oil and the 10-year Treasury, and both did precisely that. The gains this past week stemmed largely from the fact that earnings weren’t as bad as feared; well, except for some notable exceptions like Snapchat (SNAP $10), which was punished to the tune of a 40% drop on Friday.
Next week is huge. We know what the Fed is going to do, barring any surprises: raise rates by 75 basis points to an upper limit of 2.5%. We still need to get to a 4% rate (in our opinion), but investors are now banking on the fact that the velocity of hikes will begin to slow after the July FOMC meeting. In fact, many see rate cuts coming in 2023 due to a recession. Yet another reason we had better make it to 4% by then, coupled with a sizeable reduction in the Fed’s $9 trillion balance sheet. Second quarter’s initial GDP read comes out next week, which may show a second straight contraction—signaling a technical recession using an archaic metric. And talk about some critical earnings reports: Apple, Microsoft, and Alphabet all report next week. Our prediction? Except for some poorly run companies, earnings won’t be as bad as feared with the major players. We’re not really going out on the limb with that prediction: 75% of the S&P 500 firms which have already reported beat analysts’ dour estimates. Yes, the economy is cooling, but that is what happens with a normal economic cycle. Based on the bear market we entered with all of the major benchmarks except the least important one (the Dow), we are set up nicely for a second half rally.
We, 20 Jul 2022
Global Strategy: East & Southeast Asia
Latest Chinese reality check: a mortgage boycott sweeps the nation
For decades, the communist-controlled Chinese media has poured forth an endless stream of rosy stories about the country’s growth trajectory and the general happiness of ordinary Chinese citizens. Too often, a sycophantic Western press has “dutifully” regurgitated these propaganda-filled fairy tales. One such yarn revolves around the millions of housing units being built for the rising middle class in the country, and the excited would-be homeowners happily making mortgage payments on properties not yet built—a typical practice in China. Now, despite the iron-clad control over social media in the country, a darker image is coming into focus.
There is a revolt taking place among a large number of Chinese homebuyers who have stopped making mortgage payments—or are threatening to—on their unfinished properties. Despite the censors’ best efforts, online petitions are circulating urging citizens to boycott making payments until they see results. With nearly $7 trillion worth of outstanding mortgage loans, the real estate industry accounts for nearly one quarter of China’s economy; these boycotts threaten to spread like wildfire, further dampening a recovery marred by renewed Covid lockdowns. Rising loan defaults are already spooking investors, which have driven down both bank and developer stocks by double digits over the past few weeks.
How bad is the crisis? Analysts at Nomura Holdings, a Japanese financial holding company, estimate that just 60% of homes pre-sold to Chinese households over the past decade have been delivered. A slowing growth rate in the country’s economy will only exacerbate the problem.
China’s wanton real estate boom was built upon unsustainable projections of forward growth—growth levels which couldn’t possibly be sustained as its economy matured. With Xi Jinping about to become ruler for life, the problem will be exacerbated by the government’s draconian response to economic challenges.
Tu, 19 Jul 2022
Capital Markets
Another black (SPAC) eye: Electric Last Mile Solutions to be delisted
During SPACmania, 2021, companies which couldn’t dream of going public on their own joined with so-called blank check SPACs, or special purpose acquisition companies, to sneak in through the back door. The fact that investors were flocking to these creatures with force was one of the major red flags of the year, along with NFTs and meme stocks (see Feeding Frenzy, Penn Wealth Report, Vol. 9 Issue 03). Electric Last Mile Solutions (ELMSQ $0.14), yet another EV startup, was one such firm. The company became publicly traded in June of last year by joining with blank check firm Forum Merger III, initially trading at $10 per share. Now, after what the company is blaming on an SEC investigation which ultimately forced the CEO and chairman to resign, Electric Last Mile has initiated bankruptcy proceedings. On the company’s investor page, Interim CEO Shauna McIntyre assures all stakeholders that ELMS is “dedicated to the company’s ongoing business and mission.” At $0.14 per share, this “ongoing business” now has a market cap of $15.5 million, down from $1.3 billion. Management has quite the mountain to climb to make good on its current set of promises.
It is a sad testament that so many small investors would see “EV startup” and “$10 per share” and jump in with hard-earned money. No due diligence, not a modicum of research, just pure silliness. It reminds us of the guy featured on a CNBC special who declared that he spent “an entire day researching the stock market before jumping in.” Now, instead of a sober evaluation of mistakes made and an intelligent progression, how many will simply throw in the towel—until the next major rally is long in the tooth?
Tu, 19 Jul 2022
Aerospace & Defense
With shares trading around $9, Embraer looks tempting on heels of new aircraft order
Back in a 2017 article within The Penn Wealth Report, we wrote a rather glowing commentary on Brazilian aircraft maker Embraer (ERJ $9). Purchasing the company within the Intrepid Trading Platform for $20.50 per share at the time, we took a fat short-term profit (the nature of the ITP) just two months later when Boeing (BA $155) agreed to buy the $3.777 billion small-cap industrial. Since then, Boeing has pulled out of the deal and Embraer’s share price has dropped from a five-year high of $27.50 to a recent low of $8. The company, which has been around since 1969, manufactures regional and business jets as well as a host of defense and security products. Through its services and support division, the company generates a solid stream of recurring revenue.
This week, Canada’s Porter Airlines announced that it would be buying an additional 20 E195-E2 aircraft from Embraer on top of the 30 it has already ordered. The carrier also purchased the rights to buy another 50 as needed. Somewhat a slap in the face to Canada’s own business jet manufacturer, Bombardier (BDRAF $20). So, with the shares trading below $10, is it time to buy back into this now $1.645 billion foreign aerospace player? It is tempting. We have no doubt that Embraer will continue to be a viable player in the industry for decades, and it is trading almost 85% below its all-time high share price. Alas, it was a review of the income statement that kept us from pulling the trigger. While several issues jumped out, the fact that the company has not turned a profit since 2017 is certainly one of the biggest red flags. For a riskier portion of an investment portfolio, however, the potential reward might just be worth the risk.
If we did purchase Embraer, we would do so with a tight stop loss in place—probably around $8 per share—to minimize potential losses. It should be noted that every year for the past decade ERJ shares have reached the $20s to $30s range.
Mo, 18 Jul 2022
Automotive
EV maker Canoo spikes on Walmart and US Army interest; don’t be fooled
We can imagine a certain group of investors licking their chops now: EV maker Canoo (GOEV $4) is a dirt-cheap stock in a promising industry with sudden interest from both Walmart (WMT $129) and the US Army. Shares, in fact, were trading around $1.88 when America’s largest retailer said it has plans to buy 4,500 Canoo EVs with an option to buy up to 10,000. The vehicles are to be used for the store’s “last-mile delivery” to customers’ homes. A few days after the Walmart announcement, the US Army selected a Canoo vehicle for analysis and demonstration. Is the company about to have a major breakout?
Before jumping in to buy shares at the “low price” of $4.28 (where they trade as we write this), investors should dig a little deeper into the stories. As for Walmart, which stipulated in its deal that Canoo cannot provide competitor Amazon (AMZN $114) with EVs, the company has similar deals with Nikola, Daimler, and Cummins. Furthermore, Canoo has yet to deliver on any vehicles—to anyone. All of the existing vehicles are prototypes. Another major concern we have is that the company is only publicly traded because it is part of a SPAC deal. It never would have been able to go public (anytime soon) through the traditional IPO route.
On the financial front, it is common for a young company to have negative earnings, but Canoo’s top-line revenue is zero. Something that made us think back to Nikola’s slick founder, Trevor Milton, was the company’s pie-in-the-sky projections. Canoo told investors it could generate over $300 million in revenue in 2022 and produce 3,000 to 6,000 vehicles this year. The assembly lines are not yet rolling. Two years ago, the company offered revenue projections of $4.13 billion in 2026 alongside profits of $1.18 billion. These “creative” projections are raising some eyebrows in the regulatory community. Walmart and the US Army aside, $4 doesn’t seem cheap considering the potential share price of $0.00.
Headlines can spur positive actions by investors, but not always in the way one might imagine. With so many misleading narratives floating around, the ability to think like a contrarian can pay off handsomely. If something doesn’t pass the smell test, a deeper dive might uncover a real opportunity to take advantage of a misguidedly negative sentiment. In the case of the recent Canoo news, a little emotional discipline and some basic research might keep one from joining the lemmings who think they have uncovered a bargain.
Market Pulse
Despite Friday’s fizzled rally, all of the major benchmarks finished the week strong
Remember the chart of 1970’s wild S&P 500 ride we reviewed in the last issue of After Hours? Obviously, we are still very early in the second half of 2022, but our prediction of mirroring those results have been encouraging thus far. Friday’s shift from rally to fade wasn’t what we were hoping for to finish out a strong week, but it didn’t stop the S&P 500 from posting a 2.56% gain for the five sessions, surpassed only by the Nasdaq (+3.34%) and the small-cap Russell 2000 (+3.61%). There were two classes we wanted to see drop, oil and the 10-year Treasury, and both did precisely that. The gains this past week stemmed largely from the fact that earnings weren’t as bad as feared; well, except for some notable exceptions like Snapchat (SNAP $10), which was punished to the tune of a 40% drop on Friday.
Next week is huge. We know what the Fed is going to do, barring any surprises: raise rates by 75 basis points to an upper limit of 2.5%. We still need to get to a 4% rate (in our opinion), but investors are now banking on the fact that the velocity of hikes will begin to slow after the July FOMC meeting. In fact, many see rate cuts coming in 2023 due to a recession. Yet another reason we had better make it to 4% by then, coupled with a sizeable reduction in the Fed’s $9 trillion balance sheet. Second quarter’s initial GDP read comes out next week, which may show a second straight contraction—signaling a technical recession using an archaic metric. And talk about some critical earnings reports: Apple, Microsoft, and Alphabet all report next week. Our prediction? Except for some poorly run companies, earnings won’t be as bad as feared with the major players. We’re not really going out on the limb with that prediction: 75% of the S&P 500 firms which have already reported beat analysts’ dour estimates. Yes, the economy is cooling, but that is what happens with a normal economic cycle. Based on the bear market we entered with all of the major benchmarks except the least important one (the Dow), we are set up nicely for a second half rally.
We, 20 Jul 2022
Global Strategy: East & Southeast Asia
Latest Chinese reality check: a mortgage boycott sweeps the nation
For decades, the communist-controlled Chinese media has poured forth an endless stream of rosy stories about the country’s growth trajectory and the general happiness of ordinary Chinese citizens. Too often, a sycophantic Western press has “dutifully” regurgitated these propaganda-filled fairy tales. One such yarn revolves around the millions of housing units being built for the rising middle class in the country, and the excited would-be homeowners happily making mortgage payments on properties not yet built—a typical practice in China. Now, despite the iron-clad control over social media in the country, a darker image is coming into focus.
There is a revolt taking place among a large number of Chinese homebuyers who have stopped making mortgage payments—or are threatening to—on their unfinished properties. Despite the censors’ best efforts, online petitions are circulating urging citizens to boycott making payments until they see results. With nearly $7 trillion worth of outstanding mortgage loans, the real estate industry accounts for nearly one quarter of China’s economy; these boycotts threaten to spread like wildfire, further dampening a recovery marred by renewed Covid lockdowns. Rising loan defaults are already spooking investors, which have driven down both bank and developer stocks by double digits over the past few weeks.
How bad is the crisis? Analysts at Nomura Holdings, a Japanese financial holding company, estimate that just 60% of homes pre-sold to Chinese households over the past decade have been delivered. A slowing growth rate in the country’s economy will only exacerbate the problem.
China’s wanton real estate boom was built upon unsustainable projections of forward growth—growth levels which couldn’t possibly be sustained as its economy matured. With Xi Jinping about to become ruler for life, the problem will be exacerbated by the government’s draconian response to economic challenges.
Tu, 19 Jul 2022
Capital Markets
Another black (SPAC) eye: Electric Last Mile Solutions to be delisted
During SPACmania, 2021, companies which couldn’t dream of going public on their own joined with so-called blank check SPACs, or special purpose acquisition companies, to sneak in through the back door. The fact that investors were flocking to these creatures with force was one of the major red flags of the year, along with NFTs and meme stocks (see Feeding Frenzy, Penn Wealth Report, Vol. 9 Issue 03). Electric Last Mile Solutions (ELMSQ $0.14), yet another EV startup, was one such firm. The company became publicly traded in June of last year by joining with blank check firm Forum Merger III, initially trading at $10 per share. Now, after what the company is blaming on an SEC investigation which ultimately forced the CEO and chairman to resign, Electric Last Mile has initiated bankruptcy proceedings. On the company’s investor page, Interim CEO Shauna McIntyre assures all stakeholders that ELMS is “dedicated to the company’s ongoing business and mission.” At $0.14 per share, this “ongoing business” now has a market cap of $15.5 million, down from $1.3 billion. Management has quite the mountain to climb to make good on its current set of promises.
It is a sad testament that so many small investors would see “EV startup” and “$10 per share” and jump in with hard-earned money. No due diligence, not a modicum of research, just pure silliness. It reminds us of the guy featured on a CNBC special who declared that he spent “an entire day researching the stock market before jumping in.” Now, instead of a sober evaluation of mistakes made and an intelligent progression, how many will simply throw in the towel—until the next major rally is long in the tooth?
Tu, 19 Jul 2022
Aerospace & Defense
With shares trading around $9, Embraer looks tempting on heels of new aircraft order
Back in a 2017 article within The Penn Wealth Report, we wrote a rather glowing commentary on Brazilian aircraft maker Embraer (ERJ $9). Purchasing the company within the Intrepid Trading Platform for $20.50 per share at the time, we took a fat short-term profit (the nature of the ITP) just two months later when Boeing (BA $155) agreed to buy the $3.777 billion small-cap industrial. Since then, Boeing has pulled out of the deal and Embraer’s share price has dropped from a five-year high of $27.50 to a recent low of $8. The company, which has been around since 1969, manufactures regional and business jets as well as a host of defense and security products. Through its services and support division, the company generates a solid stream of recurring revenue.
This week, Canada’s Porter Airlines announced that it would be buying an additional 20 E195-E2 aircraft from Embraer on top of the 30 it has already ordered. The carrier also purchased the rights to buy another 50 as needed. Somewhat a slap in the face to Canada’s own business jet manufacturer, Bombardier (BDRAF $20). So, with the shares trading below $10, is it time to buy back into this now $1.645 billion foreign aerospace player? It is tempting. We have no doubt that Embraer will continue to be a viable player in the industry for decades, and it is trading almost 85% below its all-time high share price. Alas, it was a review of the income statement that kept us from pulling the trigger. While several issues jumped out, the fact that the company has not turned a profit since 2017 is certainly one of the biggest red flags. For a riskier portion of an investment portfolio, however, the potential reward might just be worth the risk.
If we did purchase Embraer, we would do so with a tight stop loss in place—probably around $8 per share—to minimize potential losses. It should be noted that every year for the past decade ERJ shares have reached the $20s to $30s range.
Mo, 18 Jul 2022
Automotive
EV maker Canoo spikes on Walmart and US Army interest; don’t be fooled
We can imagine a certain group of investors licking their chops now: EV maker Canoo (GOEV $4) is a dirt-cheap stock in a promising industry with sudden interest from both Walmart (WMT $129) and the US Army. Shares, in fact, were trading around $1.88 when America’s largest retailer said it has plans to buy 4,500 Canoo EVs with an option to buy up to 10,000. The vehicles are to be used for the store’s “last-mile delivery” to customers’ homes. A few days after the Walmart announcement, the US Army selected a Canoo vehicle for analysis and demonstration. Is the company about to have a major breakout?
Before jumping in to buy shares at the “low price” of $4.28 (where they trade as we write this), investors should dig a little deeper into the stories. As for Walmart, which stipulated in its deal that Canoo cannot provide competitor Amazon (AMZN $114) with EVs, the company has similar deals with Nikola, Daimler, and Cummins. Furthermore, Canoo has yet to deliver on any vehicles—to anyone. All of the existing vehicles are prototypes. Another major concern we have is that the company is only publicly traded because it is part of a SPAC deal. It never would have been able to go public (anytime soon) through the traditional IPO route.
On the financial front, it is common for a young company to have negative earnings, but Canoo’s top-line revenue is zero. Something that made us think back to Nikola’s slick founder, Trevor Milton, was the company’s pie-in-the-sky projections. Canoo told investors it could generate over $300 million in revenue in 2022 and produce 3,000 to 6,000 vehicles this year. The assembly lines are not yet rolling. Two years ago, the company offered revenue projections of $4.13 billion in 2026 alongside profits of $1.18 billion. These “creative” projections are raising some eyebrows in the regulatory community. Walmart and the US Army aside, $4 doesn’t seem cheap considering the potential share price of $0.00.
Headlines can spur positive actions by investors, but not always in the way one might imagine. With so many misleading narratives floating around, the ability to think like a contrarian can pay off handsomely. If something doesn’t pass the smell test, a deeper dive might uncover a real opportunity to take advantage of a misguidedly negative sentiment. In the case of the recent Canoo news, a little emotional discipline and some basic research might keep one from joining the lemmings who think they have uncovered a bargain.
We, 13 Jul 2022
Economics: Supply, Demand, & Prices
June inflation came in red hot, but the market drop was misguided
On Wednesday the 13th, June’s inflation numbers rolled in. They were expected to be high, but investors discounted the spike and futures were up. Within seconds of the scorching 9.1% year-over-year number being released, futures took a U-turn and tumbled some 400 points on the Dow and 200 points (-1.8%) on the Nasdaq. A 75-basis-point rate hike was already expected for July; after the report, odds of another 75-basis-point hike in September (there is no August FOMC meeting) more than doubled to around 78%. Keeping this in perspective, these two probable hikes would just put the upper limit of the Fed funds rate at 3.25%. For all the comparisons to the 1970s and 1980s, consumers could only dream about such low rates back then. The Fed should—must—make these moves.
As for the market’s immediate reaction, it was misguided. We believe that peak inflation has now hit, and that prices should begin to stabilize. Commodity prices, which have been on a steep trajectory for the past nine months or so, have turned the corner and are now pulling back at a rapid clip. Auto repossessions are exploding as an inordinate number of Americans who purchased vehicles during the pandemic have suddenly stopped making payments. Buyers and renters are pushing back against the high price of homes and 14% increase in leases by holding off on making a move—or, in the case of younger renters, moving back home. Companies of all sizes, expecting a recession, have begun to pull back on capital expenditures. Smaller companies are really feeling the pinch. Forget the American consumer for a moment: if companies start to pull back on spending, inflation will begin to subside.
Copper, a fundamental industrial-use metal, has lost one-third of its value since April. Wheat, corn, and other ag products have also dropped precipitously over the past few months. Even oil has dropped back below the $100 per barrel rate. These are signs that inflation is starting to return to more normal levels. Add a price-wary consumer to the mix, and suddenly the headline narrative begins to deflate, no pun intended. Mild recession or not, the second half of the year could hold some pleasant surprise for investors. At least the ones who resisted the urge to panic.
By “resisting the urge to panic,” we mean sticking to one’s proper portfolio diversification. On that front, we are excited by the Fed’s rate hikes as they signal some great bond issues are on the horizon. In the meantime, investors should remember that cash truly is an asset class, and a 20% allocation to that class is not excessively high right now. Dry powder to take advantage of the coming opportunities.
We, 06 Jul 2022
Airlines & Air Freight
JetBlue just can’t win: FAA awards coveted Newark slots to Spirit alone
Three miles south of downtown Newark and nine short miles from Manhattan lies Newark Liberty International Airport. Serving some 40 million passengers annually prior to the pandemic, the airport remains one of the busiest in the world. Back in 2019, Southwest Airlines (LUV $36) pulled out of the airport due to falling revenue amidst the grounding of Boeing’s (BA $135) 737-MAX fleet. This week, the FAA awarded all sixteen open slots at Newark to low-cost carrier Spirit Airlines (SAVE $25). JetBlue (JBLU $8), which has already been rebuffed twice by Spirit as a takeover target, had also been vying for the slots. A spokesperson for the FAA’s parent organization, the Department of Transportation, said that awarding all slots to Spirit would improve competition and secure more low-cost flights for Newark passengers.
A few weeks ago, JetBlue sweetened its takeover offer for Spirit, offering shareholders $30 at close and $1.50 per share in prepayment (from a raised reverse break-up fee). Spirit’s management team, however, remains committed to Frontier’s (ULCC $10) takeover offer, arguing that the deal will not face the same level of government scrutiny. (They are correct: we don’t see the respective government agencies approving a JetBlue/Spirit merger due to routing and competition issues.) Two major shareholder advisory firms, Glass Lewis and Institutional Shareholder Services (ISS), are now urging approval of the Frontier bid during this month’s shareholder vote.
It is difficult to find any airline we like right now due to inflation, a slow-moving economic slowdown, and chronic flight cancellations. We have one carrier in the Global Leaders Club, United (UAL $37), but we have a tight stop loss order on the shares. As for the airline in the direst straits (in our opinion): we wouldn’t touch shares of JetBlue.
We, 06 Jul 2022
Currencies & Forex
For the first time since 2002, the dollar is reaching parity with the euro
We always found it bizarre that certain politicians and leading economists would express a desire for a weak US dollar. Yes, our lopsided balance of trade can be aided by a weaker domestic currency, as it makes US goods cheaper for the world to buy, but the root causes of this condition are almost always troublesome. Furthermore, it harms the American consumer because their money doesn’t go as far. In essence, it is a signal that “our economy is weaker than yours.” Hardly bragging rights. For example, as the US was in the midst of the Financial Crisis of 2008/09, the euro, which was created in 1999, hit a high of €1.60 to one greenback. Many Europhiles have since predicted that parity would never be reached again. Lo and behold, the two currencies are now skirting near that level right now, with the euro hitting a two-decade low. This is due to the Fed’s willingness to raise rates until inflation is quelled, while the ECB begrudgingly signaled that it would finally raise rates by 25 basis points in July. The responsible actions on the part of the Fed add to the dollar’s strength, as global investors seek safe haven for their lowest-risk assets. While the US will probably have to battle a recession early next year, at least the Fed will have some fresh ammo; not so much the case in Europe, which is facing a deeper economic trough.
US multinational corporations do like a weaker dollar, as it makes their goods cheaper for the world to buy. The best way for an investor to take advantage of a strengthening dollar is through a bullish dollar ETF, such as the Invesco DB US Dollar Bullish fund (UUP $28), or by adjusting their portfolio toward small-cap US companies, most of whom sell overwhelmingly to domestic customers. In this space we use the Invesco S&P SmallCap 600 Revenue ETF (RWJ $103), a value/core fund which owns top revenue-producing smaller US companies.
Fr, 01 Jul 2022
Market Pulse
Worst first half of the year since 1970, but where do we go from here?
There have been a lot of comparisons to the 1970s floating around recently, and for good cause. After all, many of the same antagonists we faced fifty years ago haunt us today: China, Russia, inflation, high oil prices, and general economic malaise. Then there are the market comparisons. Yes, we have just closed out the worst first half of any year for the S&P 500 since 1970, and for the Dow Jones Industrial Average since 1962. Furthermore, the Nasdaq and Russell 2000 (small caps) just had their worst start to a year--ever. Anyone listening to the doom and gloom in the press and among economists certainly don’t feel much like buying. It is as if the all-but-guaranteed recession at our doorstep will mean the end to life as we know it. The negativism is palpable.
As we have recently noted, the entire decade of the 1970s was not kind to the markets; however, it was not just one big ten-year decline for the indexes. After dropping around 25% in the first half of 1970—eerily similar to 2022—the S&P 500 actually gained back nearly all of its losses on the back half, finishing the year down under 1%. While the Nasdaq didn’t come about until 1971, the same could be said of many of its would-be components back then.
At the end of the first half of this year, the S&P, Nasdaq, and Russell 2000 all found themselves in bear market territory, as defined by at least a 20% drop. The Nasdaq got hit the hardest, falling 30%. Bonds, which are supposed to provide a hedge to market losses, dropped 10.7% in aggregate over the past six months. Investors now seem certain on more rate hikes, a recession, terrible corporate earnings, a continuing war in Ukraine, and stubbornly persistent higher oil and gas prices. In other words, the stock market now reflects the worst of all possible outcomes for the second half.
This has created a condition in which large tech names like Microsoft, Apple, Adobe, and Amazon appear as though they are value plays. And large cap core/value names like Dollar General, Target, Pfizer, Home Depot, and Lockheed Martin have multiples that would have made investors drool last summer. All of these companies have rock solid balance sheets and strong fundamentals, it should be noted. The last time we remember solid companies selling off like this was March of 2020. June, it just so happens, was the worst month in the market since (you guessed it) March of 2020. Fear and gloom have taken over. Historically, with respect to equities, that has nearly always been the time to buy; never the time to panic.
Will the second half of the year be an encore to the second half of 1970? While we can’t say for sure, it wouldn’t surprise us a bit. Nonetheless, protection on positions and a larger allocation to cash (as we await higher rates which will lead to better bond values) are certainly prudent measures to maintain right now.
We, 29 Jun 2022
Hotels, Resorts, & Cruise Lines
Morgan Stanley analyst: Carnival Cruise Lines could go to $0 in worst-case scenario
Every time we write about Carnival Corp (CCL $9), we begin with the disclaimer that we have disliked the company and its shares for some time. A year ago, we wrote about members of senior management talking up the company’s great growth prospects while simultaneously offloading their own shares—at a much higher price than they are today, we might add. CCL shares were selling for $19 at the time. Morgan Stanley analysts have apparently had enough as well. The company maintained its “underweight” rating on the stock (why not “sell”?) while lowering the price target to $7. This helped drive the stock down some 15% at the open, to under $9 per share. Even more disconcerting was the analyst’s bear case scenario for the cruise line: the price of the shares could possibly go to $0. The catalyst for that stunningly bearish call is, primarily, the company’s debt load. Carnival holds some $11 billion worth of short-term debt and $32 billion worth of long-term debt. It has a current market cap of $10 billion. Should an upcoming recession trigger another “demand shock,” it could spell the end of the line as the company would find it very difficult to secure even more funding (at higher rates, we might add). Not everyone is so bearish, however. Six of the 24 major analysts covering the stock have a “buy” rating on the shares. Count us in the Morgan Stanley camp.
Both Royal Caribbean (RCL $36) and Norwegian Cruise Lines ($12) fell nearly double digits in sympathy with Carnival on Wednesday. For investors betting on a cruise line comeback, either of those names would offer a much better play on the industry in our opinion. (Penn does not own any cruise lines within the five portfolios.)
We, 29 Jun 2022
Global Organizations & Accords
Obstacle falls: Turkey agrees to full NATO membership for Sweden and Finland
Considering his deranged mental capacity, Vladimir Putin will never admit to the enormous tactical error he made by invading Ukraine, but it is clearly evident to the rest of the world. Based on the false narrative that Ukraine posed a threat to Russia, he invaded with the expectation of killing the country’s leader, Volodymyr Zelenskyy, and installing his own puppet regime. He has obviously failed in that attempt, but the unintended consequences of his barbaric act can be summed up with one stunning development: NATO is coming to Russia’s northwestern doorstep.
The one obstacle holding back Sweden and Finland’s membership into the military alliance was Turkey, which has been in the group since 1952. Based on the group’s bylaws, any expansion required approval by all member-states. Turkey had opposed the Nordic countries’ ambitions to join due to their respective governments’ support for Kurdish “terrorists” allegedly residing within the two nations. Now, according to Turkish President Recep Tayyip Erdogan, those concerns have been assuaged, leaving a clear path toward membership. Erdogan’s announcement came at the alliance’s Madrid Summit, which can now focus on its plan to rebuild forces in Europe to counter the increased Russian threat. That country has threatened to station nuclear weapons along its border with Finland if the nations were admitted to NATO.
Back in the 1990s, following the fall of the Soviet Union, many misguided critics questioned the need for NATO to remain in existence. Today, it is once again as important as it was during the height of the Cold War.
The final straw which ultimately brought about the fall of the Soviet Union was Ronald Reagan’s Strategic Defense Initiative and the communist nation’s attempt to counter the program. History may well repeat itself: Russia is ill-equipped to counter a strengthened NATO on its border, but Putin will spend critical capital trying to do just that.
We, 22 Jun 2022
Municipal Bonds
Alabama finds underwriters for $725 million worth of tax-free prison bonds
Breaking down a rather complicated series of events, here is what is going on in Alabama with respect to the improvement of conditions for prisoners, and the funding of these upgrades. The state faced a lawsuit from the DoJ which alleged that inmates housed in the state’s prisons were being exposed to “cruel and unusual punishment” due to dilapidated conditions. One such building, the Draper Correction Facility, had been in operation since 1939. To answer these concerns, the state contracted with CoreCivic Inc (CXW $12), a specialty REIT, to build and operate newer facilities, leasing them back to the Alabama Department of Corrections.
To fund the projects the state planned to offer municipal bonds, with the debt being backed by annual appropriations to the Department of Corrections. After backlash over the privately built and managed facilities, Barclays Plc and KeyBanc Capital Markets, the primary underwriters, dropped out of the deal. A CoreCivic spokesperson called the activists “reckless and irresponsible” for (apparently) preferring to have inmates remain in the outdated facilities rather than support a public-private enterprise.
Now, the deal has a new set of underwriters: Alabama-based Stephens Inc and The Frazer Lanier Company will co-manage the sale, along with help from Raymond James, Wells Fargo, and several other backers. The bonds will carry an Aa2 rating by Moody’s and a AA- rating by S&P Global. The yield on these tax-free general obligation (GO) bonds has yet to be announced, but they should hit the muni bond marketplace within the next month.
As rates bottomed out and the world was in the midst of the pandemic, there was a dearth of new muni bond issues. While the US faces a probable recession early next year, higher rates and the need to rebuild the American infrastructure should present investors with a huge wave of new tax-free bonds. Who knows, they may even get close to the 5% range many of them offered income-oriented investors back in the early years of the century. We would settle for a 3% tax free rate.
We, 22 Jun 2022
Beverages, Tobacco, & Cannabis
In blow to Altria, the FDA is poised to order Juul e-cigarettes off the market
In a rather stunning turn of events, the Food and Drug Administration is preparing an order that would force Juul Labs to take its popular e-cigarettes off American shelves. This follows a two-year review of the products, specifically the fruit flavored blends. The FDA’s ruling serves as a capstone to the great downfall of Juul, which was flying high back in 2018 as its products soared to the top of a frenzied market. In what turned out to be a critical miscalculation, 2018 also happens to be the year that tobacco giant Altria (MO $41) decided to take a 35% stake in the company. What might have seemed like a reasonable move to diversify away from its traditional cigarette products (Altria owns the popular Marlboro brand, among others), the company bought in at the worst possible time. Shares of MO had been holding up quite well in 2022 thus far, sitting at where they were trading going into the year. As soon as the news was announced, shares fell 10% and remained stuck there. The 2018 deal valued Juul at around $35 billion; just prior to the FDA decision, the company had a valuation of roughly $5 billion. Adding insult to injury, the FDA also indicated that e-cigarettes made by rivals Reynolds American and NJOY Holdings would be allowed to continue selling their tobacco-flavored vaping devices. Juul lost around $259 million on sales of $1.3 billion in 2021.
Somewhat surprisingly, there are still some Altria bulls out there. In addition to a fat 7.88% dividend yield, the company has maintained annual revenues of between $24 billion and $26 billion per year for the past ten years and has generated positive net income in all but one (2019) of those years. We wouldn’t touch the stock, especially considering the firm spun off its international division—Philip Morris International (PM $99)—back in 2008.
Tu, 21 Jun 2022
Currencies & Forex
Japanese yen falls to a 24-year low against the dollar
If you have been considering a Japanese getaway, now might be the time to book that trip. As of this week, one US dollar will buy 135 yen, up from slightly over 100 at the start of the year. Why does the world’s third-most-traded currency continue to plummet? Because the Bank of Japan’s governor, Haruhiko Kuroda, stands firmly by his commitment to maintain a -0.1% short-term interest rate while the rest of the developed world is raising rates to tamp down runaway inflation. Angering the Japanese public with his recent comments that consumers were becoming more tolerant of higher prices, nearly 60% of the country’s residents now find him unfit for the job. A weak currency due to an easy money policy means that goods and services cost a lot more for consumers within that country, and a lot cheaper for foreign visitors thanks to the generous exchange rate. Yes, a weak currency promotes stronger exports because the goods are less expensive for the world to buy, but the tradeoff can be brutal for the family budget. For a country which imports 94% of its energy, soaring prices and a weaker yen have most cheering the fact that Kuroda is in the final year of his second term as governor of the central bank.
For investors, the yen’s weakness also makes the Japanese stock market look more attractive thanks to the currency disparity. One way to potentially take advantage of this weakness is through the WisdomTree Japan Hedged Equity Fund (DXJ $64), which is up 2.35% in value this year against the backdrop of an 18% decline in the MSCI All-Cap World Index, Ex-US. Some of the fund’s top holdings are Toyota Motor Corp, Nintendo, Mitsubishi, and Canon.
Tu, 21 Jun 2022
Food Products
Kellogg to break into three companies; does anybody care?
Five years ago, we wrote a brief piece on Kellogg’s (K $69) hiring of a new CEO after floundering for years under chief executive John Bryant. We expressed doubt that Steven Cahillane would be any different. At the time, K was sitting around $70 per share. Confirming our concerns, the shares have barely budged since.
So, what does a mediocre company do to move the needle on its share price? Announce a plan to split into multiple entities, of course. Sure enough, shares of Kellogg opened the week up nearly 4% after management announced it would break into three pieces: a global snacking company, a North American cereal company, and a plant-based food company, names to be decided at a later date. We are not talking about GM spinning off its financing unit (remember GMAC?) or GE spinning off its jet-leasing unit; we are talking about a food company spinning off…food companies. Aren’t all three units within the core competencies of a packaged food manufacturer?
Right out of the mediocre manager playbook, CEO Cahillane said that the standalone companies will now be able to “direct their resources toward their distinct strategic priorities…and create more value for all stakeholders….” What a bunch of gobbledygook. Milquetoast executives throw out terms like “unlock value” as if a split would magically open corporate treasure chests which the crackerjack team had just been unable to open in the past. Really? All of the talent at your fingertips and you just couldn’t crack the code, but now you will be able to? What will be fun to watch next is how many middling analysts get excited by this move and upgrade the shares. Insert eye roll emoji here.
Full disclosure: We own Kellogg’s chief competitor, General Mills (GIS $68), in the Penn Global Leaders Club.
Th, 09 Jun 2022
Aerospace & Defense
BWX Technologies wins DoD contract to build first advanced microreactor in US
Aerospace & Defense firm BWX Technologies (BWXT $54) has been awarded a contract by the United States Department of Defense to build a first-of-its-kind advanced nuclear microreactor. Under codename Project Pele, these reactors, which can be transported by modules aboard trucks, trains, aircraft, or ship, are designed to be assembled on-site and operational within 72 hours. The reactors can provide a resilient power source for a variety of operational needs, eliminating the need for fossil fuels delivered by often extensive supply lines. The possibilities are endless, from immediate power needs at remote locations, to disaster response and recovery around the world. The prototype will be built under a contract valued at around $300 million and should be completed and delivered by 2024 for multiyear testing at the Idaho National Laboratory.
As we move away from fossil fuels, these advanced concepts are going to come to fruition, and the industry is full of potential going forward. A lack of understanding and a fear of the word “nuclear” may slow the process, but the safety attributes of these devices will eventually allow them to become embraced by politicians and the general population. BWX Technologies is a $5 billion specialty manufacturer and service provider of nuclear components. Additionally, the Lynchburg, Virginia-based firm provides uranium processing, environmental site restoration services, and other solutions to the nuclear power industry. With average annual revenues around $2 billion, the company is perennially profitable.
We, 08 Jun 2022
Renewables
Solar stocks surge on Biden’s decision to hold off on new solar tariffs for two years
Investing in the solar energy movement has always been fraught with danger, with the slightest shift in sentiment or any new legislative (or executive) actions generally causing an oversized reaction by investors in the industry. The latest news on the latter front, however, had solar enthusiasts cheering. The Biden administration announced there would be no new tariffs placed on solar panel imports for the next two years. There had been a major push underway by the US Department of Commerce to investigate whether global solar panel suppliers were using deceptive tactics to avoid getting hit with tariffs on goods emanating from China. That push, along with supply chain constraints, led to a major slowdown in solar panel installation in the US. In a decision we find more impactful on the US economy, the president also signed three executive orders designed to increase domestic production of solar panels. Tesla, which had been in partnership with Panasonic to produce such panels at a Buffalo, New York facility, has since exited the production side of the business and now focuses solely on installation of the systems.
The Invesco Solar ETF (TAN $78) has been on a roller coaster ride this year, dropping 25% before rebounding to flat YTD. The new legislation, along with soaring energy prices, could provide a catalyst for the companies within this fund in the second half of the year. Enphase Energy (ENPH $214) is the largest of the fund’s 42 holdings, with a 12% weighting.
While we do not currently own any direct solar plays in the Penn strategies, we do own Tesla (TSLA $737), a major renewables player and lithium-ion battery manufacturer, in the New Frontier Fund.
We, 01 Jun 2022
Monetary Policy
The Fed will finally start reducing its $9 trillion balance sheet this month
It is hard to imagine, but just nineteen years ago, in 2003, the Federal Reserve had around $700 billion of assets on its balance sheet. That amount, it should be noted, is one component of the national debt. After the financial crisis of 2008-09, the balance sheet more than tripled, hitting $2.25 trillion. At the time, those figures were hard to fathom. Quadruple that amount and we have the current size of the Fed balance sheet. June is the month the figure finally begins going down.
Four large Treasury securities held by the Fed, worth $48.25 billion, are maturing this month. In previous months, the Fed would have reinvested the proceeds, purchasing an equal amount of new securities. Instead, it will let $47.5 billion simply run off the balance sheet, only reinvesting the final $1 billion or so. It will continue this process until September, at which time it will double the amount allowed to mature without reinvestment, reducing the balance sheet by $95 billion per month. This may seem like a rapid pace, but it will only amount to a $522 billion reduction by the end of this year, and an additional $1.1 trillion by the end of 2023. If the downward trajectory continues, the Fed balance sheet will be back to pre-pandemic levels by the summer of 2026.
That date may seem far in the future, but there is something even more unsettling about the entire process: we will probably never get there. The continued reduction is contingent upon the economy humming along between now and June of 2026. Does anyone really believe that yet another “urgent crisis” will fail to manifest? Our best hope is that the balance sheet is reduced by a few trillion dollars before the Fed is forced to go on its next buying spree.
Rarely are two of the Fed’s three main tools used in tandem, at least to this degree: an increase in short-term rates plus a simultaneous reduction of the balance sheet through open market operations. These two actions will undoubtedly have an impact on the housing market specifically, and the overall economy in general. Hence, the doubt expressed by economists that the Fed can execute a “soft landing” as opposed to fomenting a recession. A fascinating case study to watch.
Tu, 31 May 2022
Food & Staples Retailing
The dollar stores provide a much-needed positive catalyst for the markets
Certainly with respect to retailers, it seems all we have been hearing about lately is margin contraction. Consumer Staples companies, which sell the goods people need under all economic conditions, have been maintaining their gross sales levels, but their net profits have shrunk due to higher input, labor, and transportation costs, as well as disruptions in the supply chain. In other words, inflation is killing their bottom line.
Assuming the so-called dollar stores (Dollar General and Dollar Tree primarily) would suffer the same fate at their larger brethren such as Walmart and Target, these companies had their respective share prices hammered in sympathy. All the bad news was priced in before the numbers ever came out. This was true more so for Dollar Tree (DLTR $164), which carries a larger percentage of discretionary items than does Dollar General (DG $228).
Lo and behold, both companies surprised to the upside, sending shares of DG and DLTR up by double digits. Dollar General announced revenue of $8.8 billion, earnings per share of $2.41, and a negligible decline in same-store sales. The company also raised its full year sales guidance and maintained its bottom-line income projections. Dollar Tree posted revenues of $6.9 billion and earnings per share of $2.37, also beating analysts’ predictions, and raised its full year guidance.
How are these low-cost darlings able to withstand inflation better than their larger competitors? Primarily, the answer revolves around management’s effective use of inventory tactics to preserve profits. Dollar General CEO Todd Vasos, for example, explained that the company can shift to substitutes when certain goods go up in price. They have also added self-checkout lanes to over 8,000 stores and have plans to turn another 200 locations into self-checkout only, thus reducing labor costs. For its part, Dollar Tree’s decision to raise the price of its $1 items to $1.25 hasn’t had any detrimental effect on sales. Finally, as could be expected, higher prices are driving more and more Americans to visit these stores; names which they may have shunned in the past. Expect this trend to continue through next year, as the US faces a probable recession.
We have long regarded Dollar General as one of our most defensive plays in the Penn Global Leaders Club. Even after the economy troughs in 2023 or 2024 and begins a new expansion phase, the unique value proposition of the company—such as where the stores are located—means it will probably remain a core holding in the strategy.
We, 25 May 2022
Fintech
AI-powered ETF is facing its first major test, and the results have not been pretty
We recall being intrigued about five years ago when we heard of the AI Powered Equity ETF (AIEQ $32), the so-called robot-managed exchange traded fund. This automated, data-driven fund would “harness the power of IBM Watson to equal a team of 1,000 research analysts, traders, and quants working around the clock.” Using artificial intelligence instead of human brainpower, predictive models would be built on some 6,000 US companies. These models would analyze millions of data points across news, social media, financial statements, and analyst reports to build a more efficient fund. Between 30 and 200 companies with the greatest growth potential over the following twelve months would be purchased, with adjustments being made constantly. Truly a fascinating concept.
It is always a good idea to let concepts prove themselves before jumping in, so we held off on adding AIEQ to the Penn Dynamic Growth Strategy—our ETF portfolio. Watson is certainly an incredibly powerful tool which may enhance a plethora of different industries, but wasn’t it the machine behind our weather app which we were less-than-impressed with? Perhaps Watson could have even predicted how AIEQ would perform in a downturn, but we wanted to find out the old-fashioned way.
Unfortunately, the fund got a chance to prove itself following the worst market start to a year since 1970. Based on the rather impressive breakdown of holdings (roughly an equal representation in Health Care, Industrials, Technology, and Consumer Cyclicals, followed by Financial Services, Consumer Defensives, and Basic Materials companies), the benchmark for the fund would be the S&P 500. While that key market benchmark has given up around 17% year-to-date as of this writing, AIEQ is down 23.84%. We expanded the scope of our comparison to include the Dow Jones Industrial Average (30 holdings), the NASDAQ (primarily tech names), and the Russell 2000 (small-cap proxy). Only the NASDAQ composite, with its 27% loss, underperformed the fund. The narrative was excellent; unfortunately, the results were not. Back to the drawing board.
The Penn Dynamic Growth Strategy (PDGS) is currently comprised of 25 holdings; overwhelmingly ETFs (due to their intraday liquidity, lower general costs, and other factors), and a couple of open-end mutual funds which we rate as exemplary. The Strategy uses a core/satellite approach, with the satellite funds being more tactical in nature (Invesco DBA Agriculture ETF is a great example). The PDGS is actively managed, with changes being made based on the economic, investment, and geopolitical environment.
We, 25 May 2022
Interactive Media & Services
Snap shares just fell 43% in one day; in 2017, we called the company’s share class structure a sham
After social media company Snap (SNAP $13) lowered its outlook for the year—ultimately causing shares of Snapchat’s parent company to fall 43.08% in one day—we immediately began perusing our past notes on the firm. Our first comments came in February of 2017 as the company was about to begin its IPO roadshow. Setting a price target of between $14 and $16 per share, the company would immediately have a $20 billion market cap in what would be the largest US tech offering since Alibaba (BABA $82) went public in 2014. We urged investors not to bite. The roadshow was such a success that the IPO shares were more than ten times oversubscribed. They ultimately priced at $17.
Our next note on Snap came just a month later, in March of 2017. This time we said that investors were getting a raw deal with respect to the share class structure. Get this scheme: The company would sell schmucks like us Class A shares, which came with no voting rights but did “entitle” buyers to attend the annual shareholders’ meeting and “ask questions.” Gee, thanks. Executives of the company could acquire Class B shares, which came with one vote each, while Snap’s founders would own the coveted Class C shares which came with ten votes apiece. Talk about some fancy financial engineering.
The catalysts for our other notes on Snap were earnings reports. In all but one case, shares had plummeted on lower-than-expected numbers or worse-than-expected guidance. The latter was the cause for Tuesday’s 43.08% drop, taking the shares down to $12.79, or 25% lower than the $17 per share initial offering price. What a mess.
SNAP shares now sit 85% off their September 2021 highs. Some might see a bargain; we still see an aristocracy in which the company’s rulers have no idea what they are doing.
Mo, 23 May 2022
Market Pulse
Consumer staples fell dramatically last week, but the Dow is attempting a comeback
If there was one positive sign in this five-month-long anxiety-riddled market tumble, it had been the fact that consumer staples—those stolid, earnings-rich companies that sell goods people need under all economic conditions—were holding their own. That changed last Wednesday after Target (TGT $155) shocked the market with news that profit margins were getting seriously crimped by high inflation—from higher fuel costs to a spike in commodity prices. This exemplary company, which was up around 300% since we added it to the Global Leaders Club, lost one quarter of its value in one day; its worst one-day hit since 1987. And it wasn’t just a Target problem. The prior day, Walmart’s (WMT $122) earnings showed the same challenges, pushing WMT shares down 11%. Ironically (or not), that was also their worst single day since 1987.
We all know what happened in 1987. I was in the US Air Force rather than a cushy chair at an investment firm back then, but I remember the fear being palpable. There really wasn’t a single major catalyst that would explain away the massive market drop, which was part of the problem. Investors feel better if they can point to a viable reason for a system shock, and there wasn’t one in October of 1987 (though there was a confluence of events, much like today). Many investors made the worst possible mistake that month: they began selling even their best positions. Over the course of the next six months or so, the Russell 2000 (small caps) had rallied 37%, the NASDAQ was up 32%, and both the S&P 500 and Dow were up 20%. Those who sold in October missed a remarkable rally right around the corner.
This is not March of 2000. The current bear market much more closely resembles the one which occurred in the fall of 1987. Inflation is real, and the Fed will do what it takes to get it under control (raise rates and reduce the balance sheet), which may push the economy into a mild recession next year. But we wouldn’t be surprised to see the same type of rally occur in the second half of this year that began on 7 December 1987. Friday afternoon and Monday’s follow through may portend that coming rally: the Dow was down over 600 points with a few trading hours left in the week, only to rally into a positive close. That rally continued Monday, with the Dow finishing up 618 points—or more than 1,200 points higher than Friday afternoon’s low. Of course, we have no way of knowing whether the bottom of this current market downturn is in, but it is refreshing to see buyers jumping back in after being pummeled for seven straight weeks.
We, 18 May 2022
Editor's Corner
Don't wave the American flag while watching your cargo ships roll in...
We have preached repeatedly about the irresponsible manner in which so many American companies became overly reliant on a communist nation with respect to trade; how executives became seduced by a massive population for the sale of their goods, and a dirt cheap labor force for the production of those goods. Distressingly, it took a global pandemic originating from that country for many of these companies to (finally) look at reducing their country risk. Still, the narrative these firms weave for public consumption is enough to make us choke.
One major US retailer has a "Made in America" campaign running to proudly proclaim how the goods they sell are made in the US. They use a flower grower as an example. Try finding a flashlight or a can opener at this retailer made anywhere around the globe other than China. You won't.
We are not xenophobes by any stretch, and we still support companies which source from factories in virtually any country outside of China, Russia, North Korea, or Iran. That being said, more can and should be produced domestically. Especially with the Fourth Industrial Revolution at our doorstep, with many American technology firms and universities leading the charge. What can we, as consumers, do to help the process along? We can get in the habit of checking where the goods we buy are actually produced, and providing feedback via direct contact and social media when we don't like what we see.
Tu, 17 May 2022
Construction Materials
Armstrong Flooring paid out $4.8 million in bonuses to execs—then declared bankruptcy
The world of home flooring is one of those murky, opaque realms in which performing due diligence is extremely difficult—often by design. Take, for instance, a home buyer who wants to assure their builder uses wood flooring sourced from anywhere but China. Good luck. The company may be American, and their final products may be designed and even produced in the US, but that doesn’t mean the “cores” of factory-made materials didn’t come from the communist nation. Which leads us to a recent story about Armstrong Flooring (AFI $0.32).
While we couldn’t readily determine what percentage of the company’s wood flooring materials emanated from China, at least they had the courage to admit—clearly on their website—that they do have a flooring plant in the Jiang Su Province of that country—in addition to plants in the US and Australia. We point this out because the company cited supply disruptions and higher transportation costs as two of the reasons it was forced to declare bankruptcy this past week. Never fear, though, as the company fully plans to continue operating while in bankruptcy while it devises plans to emerge. Armstrong told the Delaware court that it owed some $300 million to creditors and has roughly $500 million worth of assets, giving it a debt-to-equity ratio of 61.5%—up from 28.3% in March of 2020 and 17% in September of 2018.
We are happy for the employees of Armstrong, but we must wonder how happy they were to learn that senior executives received some $4.8 million worth of annual incentives just before the company declared bankruptcy; incentives that would have almost certainly been disallowed by the courts. An Armstrong attorney told US Bankruptcy Judge Mary Walrath that these execs (the CEO and at least three others) were key in securing funding, but aren’t the employees key as well? It should be noted that the company’s CEO was the “chief sustainability officer” at Mohawk Industries between 2017 and 2019. It should also be noted that Armstrong had 1,600 employees as of the end of 2021. That $4.8 million would have meant a nice bonus of $3,000 for each, and we will even include the top executives in that package.
We love American free enterprise, which is why we must hold all companies to the highest possible standard. We are not accusing Armstrong of doing anything illegal or even unethical, but companies that wave the American flag and wax eloquent about sustainability had better make sure they are practicing the ethics they preach. The last year Armstrong Flooring turned a profit was 2016, which happens to also be the year that Armstrong World Industries (AWI $84) offloaded the firm as its own publicly traded company, trading in the $19 range. These decisions don’t happen in a vacuum, and it behooves investors to look well beyond the glossy ads and company websites when reviewing a company for possible purchase. Pull up the rug and see what’s underneath, so to speak.
Tu, 17 May 2022
Global Organizations & Accords
Turkey’s objection to Sweden and Finland joining NATO is all about personal gain
Turkey has never been a faithful ally to the West. While desiring to be considered a mainstream Western European country, it has acted in the best interest of the Middle East. While demanding arms from the United States, it gladly accepts a missile defense system from Russia. President Recep Erdogan “massages” the country’s constitution to remain firmly ensconced in power while political opponents are dealt with swiftly and harshly. Now, as two truly European countries, Sweden and Finland, begin their application for formal membership into NATO, Erdogan runs interference, knowing full well that all current members must approve their entry.
Erdogan’s position, as usual, has nothing to do with the common good and everything to do with his own greed and self-enrichment. While claiming that the two Nordic countries need to clamp down on “Kurdish terrorist activities” in the region, he has no problem inciting—or outright approving—terrorist activities at home. Knowing full well that his approval is needed, expect this would-be dictator to successfully milk a host of concessions out of Europe before bestowing his magnanimous blessing on a strengthened NATO. While his good friend Putin won’t be happy with this ultimate decision, Erdogan will have enriched himself, yet again, by playing the dirty merchant of Europe.
On a scale of 1-9 on the democracy meter, Turkey has an abysmal rating of 4.35—more in the proximity of a Russia or a China as opposed to those of its Western neighbors. This won’t change as long as Erdogan is in power, and we don’t see him loosening his grip on that power any time soon.
Tu, 17 May 2022
Airlines
JetBlue is going hostile for Spirit, and it is a complete waste of time
We know how much the big four US-based airlines—American, United, Southwest, and Delta—were financially impacted by the pandemic, and quite understandably so. It follows, then, that the smaller players would be in even rougher shape following the two-year nightmare. Consolidation within the industry among these smaller players makes sense, and we reported this past February of Frontier’s (ULCC $9) plans to acquire Spirit Airlines (SAVE $19) in a deal valued at $2.9 billion ($6.6 billion with debt added in). Another small-cap player, JetBlue (JBLU $10), felt threatened by this move (rightfully so), and made its own offer to buy Spirit for $3.6 billion in an all-cash offer. Interesting, as the market cap of JBLU is just $3 billion. Not seeing a path toward regulatory approval, Spirit said thanks, but no thanks.
Which leads us to JetBlue’s current tactic: going hostile. Denouncing Spirit’s management team for refusing to perform due diligence with its offer, the company said it will actively pressure SAVE shareholders to reject the Frontier bid at a 10 June meeting. Bizarrely, JetBlue said that it would raise its $30 per share offer to $33 per share if management comes back to the table and provides the financial information being requested. That does nothing to alleviate the real problem: we see no circumstances under which the antitrust forces at the Department of Justice and the Federal Trade Commission will allow the JetBlue/Spirit deal to go through. In fact, Spirit CEO Ted Christie has explicitly stated that this may simply be about foiling the Frontier deal. We believe his argument will carry the day with shareholders. A combination of any two of these players would create the country’s fifth-largest airline, leapfrogging over Alaska Air Group (ALK $47).
JetBlue has a host of problems which Spirit wants nothing to do with, to include a worst-in-class, 62% on-time rate. Furthermore, the carrier is already in the Justice Department’s crosshairs, as the agency sued to block the airline’s regional partnership with American Airlines last year. Ultimately, we see the original Frontier acquisition getting approved, which will make JetBlue’s position in the industry even more tenuous.
Mo, 16 May 2022
Aerospace & Defense
Ryanair’s fiery Irish CEO loves Boeing, but “management is a group of headless chickens”
We love CEOs who are true leaders, are interesting characters in their own right, and who don’t feel the need to insert themselves into the political arena to score sycophantic points with super-sensitive stakeholders. Irish low-cost carrier Ryanair’s (RYAAY $81) fiery CEO, Michael “Mick” O’Leary, easily checks all three boxes. When Boeing’s (BA $126) hapless CEO, David Calhoun, is on one of the business networks, we mute the TV to avoid hearing the canned hot air delivered with a strained jumpiness; when we see O’Leary’s face, we always listen with rapt attention. A little background on Ryanair’s history with Boeing: the company has always been one of the aircraft maker’s most loyal customers. A European airliner with a fleet of 471 Boeing aircraft, 145 more on order, and just 29 Airbus (European) aircraft. That made us applaud all the louder when, during a Ryanair earnings call, O’Leary blasted Boeing’s management team and its inability to make good on orders. Saying they need to “bloody well improve on what they’ve been doing…,” he added that, “At the moment, we think the Boeing management (team) is running around like headless chickens.” Hey, that’s just what we have been saying ever since Calhoun anointed himself—with the Board’s blessing—CEO! Hear, hear! How refreshing to have a leader who tells it like it is. We could quickly list a dozen major US companies which could use someone like O’Leary at the helm.
Our minuscule impact on Boeing is limited to not owning it in any of the Penn strategies. We have to believe that the words of a Boeing cheerleader and major customer would have some major sway in the industry. Then again, Boeing has proven itself to be quite tone deaf since Jim McNerney left the firm in 2015, so who knows. It is probably the customer’s fault, right?
Mo, 16 May 2022
East & Southeast Asia
For the US, there was only one direction to go in the Philippines after Duterte
Many of us vividly recall the presidency of Ferdinand Marcos, and the endless stories written by the American press about his wife Imelda’s shoe collection. We thought back to his regime, which ended with a thud in 1986, this past week as his son, Ferdinand “Bongbong” Marcos Jr., notched a landslide election victory to become the next president of the Republic of the Philippines. For the United States, the importance of having a strong ally in this strategically critical region of the world cannot be overstated. Once one of America’s staunchest advocates in Southeast Asia, the country moved decidedly away from its old friend—and toward China—under President Rodrigo Duterte’s six-year rule. Until a last-minute change of heart, in fact, Duterte had all but cut military ties with the US by threatening to end the longstanding Philippines-United States Visiting Forces Agreement (VFA).
Along with the election of Marcos Jr., Filipinos sent a clear message that they do not wish to be subservient to their would-be Chinese masters. Overwhelmingly, voters expressed their unease with Duterte’s cozying up to China’s Xi Jinping. For its part, American military exercises in the South China Sea have enraged China, and the country’s ruling communist party has done everything it could to poison the relationship—not a difficult task with the mercurial Duterte in power. Now, with a huge favorability rating he does not wish to squander, we can expect Marcos to govern in a manner more conducive to overall stability in the region, and that is not what China had been hoping for.
Even though Duterte’s own daughter is the vice president-elect, this election was a clear victory for America’s interests in the region; as much of a victory, in fact, as the March election of Yoon Seok-youl in South Korea. Controlling the South and East China Sea regions are a linchpin to China’s grand ambitions, and the citizens of South Korea and the Philippines have indicated precisely what they think of those plans.
We, 11 May 2022
Automotive
Before a meme stock-like comeback, Carvana shares dropped 92% in nine months
Back in August of last year, used auto platform Carvana (CVNA $30) could do no wrong. Despite a lack of positive net income in any given year over its ten-year history, the company’s sales growth was spectacular, growing from $42 million in 2014 to $11.77 billion in 2021. Investors rewarded the competitor to such names as Carmax (our favorite in the space), Cars.com, and Autotrader by driving CVNA shares up to an intraday high of $376.83 on 10 August 2021. Fast forward precisely nine months, and traders are fleeing the maker of the highly unique Carvana Vending Machines. Shares hit a new 52-week low of $29.13 on the 11th of May after management announced a 12% reduction in its workforce; that price represents a 92% drop from the August highs. Another reason investors soured on the company was news of its acquisition of Adesa US, the wholesale vehicle auction division of KAR Auction Services, for $2.2 billion. Not due the acquisition itself, but the financing scheme: Carvana would be issuing $3.3 billion in junk bonds carrying a yield of 10.25%. In decades gone by, that might seem fine for a junk bond rate; today, it seems too good to be true (for bond buyers). Longtime Carvana investor Apollo Capital Management agreed to secure some $1.6 billion of that paper. As for the layoffs, which equate to roughly 2,500 employees, the company told the SEC that senior management would not collect any salaries for the remainder of the year to help fund the severance packages.
We feel for the investors who bought shares in the company last August. Price targets now range from $40 to $470 among analysts on the Street, but we wouldn’t touch the shares right now—or the 10.25% bonds. The company’s cash burn rate will be hard to sustain, even with the new round of funding.
Fr, 06 May 2022
Week in Review
Despite a hopeful FOMC day, markets suffered their fifth straight week of losses
It would be nice just to focus on Wednesday. Yes, that was the day the FOMC raised rates 50 basis points, the most since May of 2000, but the markets cheered when the Fed Chairman took a 75 basis point rate hike off the table. Between that comment and his belief that the Fed can pull off a “softish” landing, markets took to rallying: the Dow Jones Industrial Average gained 932 points and the NASDAQ rose 3.19%. Unfortunately, there were four other days in the trading week. Like the happy partygoer who wakes up the next day and asks, “what the * was I thinking?” the major benchmarks all made a swift change in directions. The Dow, in fact, shed over 1,000 points for the first time since the spring of 2020. Even a really strong Friday jobs report seemed to irritate the markets. The week’s drop signified the fifth straight down week for the benchmarks, and the worst start to a year since 1970. And that is not a decade we wish to see repeated. We said to expect wild market fluctuations and plenty of volatility during the rate hike cycle, and that certainly manifested itself this past week. The good news? Plenty of great, revenue-generating, industry-dominating American tech giants are now selling at bargain basement valuations. And for the record, we believe investors will be pleased with where the major indexes end the year—especially from the current vantage point.
Fr, 06 May 2022
Under the Radar
Hanesbrands Inc (HBI $12)
I rediscovered Hanes while on a search for socks, t-shirts, and briefs that were actually manufactured somewhere other than China. Sadly, that is a lot harder task that one would assume. In the end, Hanes was the one brand which came shining through. Channeling my inner Peter Lynch, I decided to do a deeper dive into HBI stock. Founded in 1901 and based out of Salem, North Carolina, Hanesbrands includes the Hanes, Champion, Playtex, Maidenform, Bali, and Bonds (Australia) labels. Importantly, this company is vertically integrated: it produces over 70% of its goods in company-controlled factories across some three dozen countries. Unlike a troubling percentage of other American manufacturing firms, it never hitched its wagon to communist-controlled China. In addition to its vertical integration (a major plus considering current supply chain issues), management has successfully created a vibrant omnichannel network. The company sells wholesale to discount, midmarket, department store, and direct to consumer via an impressive online and digital presence. At $12 per share (down from a high of $34.80 and sitting at a 52-week low), this $4.4 billion small-cap value company has a forward P/E of 7.5, a tiny price-to-sales ratio of 0.6520, and a fat dividend yield of 4.72% based on current share price. With a new strategic plan called Full Potential, CEO Steve Bratspies—formerly an Executive Vice President and the Chief Merchandising Officer at Walmart—has a clear vision of where he wants to take the company. We are betting he succeeds. We would conservatively value HBI shares at $24 apiece.
Th, 05 May 2022
Monetary Policy
Fed raises rates most in one meeting since May of 2000; let’s hope the trend continues
In May of 1999, twenty-three years ago this month, the upper limit of the federal funds rate (FFR) was sitting at 4.75%. In an effort to prevent runaway inflation and cool the scorching-hot US economy, the Fed began raising interest rates. It capped that effort one year later, in May of 2000, when it raised rates 50 basis points, from 6% to 6.5%. Why is that history lesson important? Because, to staunch already-runaway inflation, the Fed just made its biggest move since that meeting twenty-two years ago: the Committee spiked rates (upper limit) from 0.50% to 1%. The history lesson also brings home another point. When rates topped out at 6.5%, the central bank had an enormous amount of room to tighten as it worked to avoid recession, which it did (lowering rates) between 2001 and 2003. The accompanying graph provides a wonderful visual for the difference between then and now. Rates must continue to go higher. At the very least, we need to get back to the average FFR of 2.5%. To do so in a timely manner would entail another 50 basis point hike at both the June and July meetings, respectively, and a 25 basis point hike in both September and November. Unless inflation shows real signs of cooling, that is the scenario we can expect to play out. We can also expect a few hikes in 2023, bringing the FFR up to 3% or higher.
In addition to the hike, Fed Chair Jerome Powell also announced a systematic paring back of the Fed balance sheet, which remains just shy of $9 trillion. More perspective: that debt load sat well below $1 trillion back in 2000. Starting in June, that astronomical figure will be reduced by $95 billion per month, equaling a $1.1 trillion reduction by May of 2023. Again, a good start.
With any luck at all, inflation can be tamed without the rate hikes pulling us into a recession until 2024—though the latter scenario may well play out in 2023. The longer we can keep a recession at bay, the more ammo the Fed will have leading into the next tightening cycle.
We, 04 May 2022
Education & Training Services
Textbook company Chegg’s market drop following its earnings release was irrational
Despite the fact that we like Education and Training Services company Chegg (CHGG $17), we knew it was overvalued when the shares were trading north of $100. Now, after falling some 85%—yes, you read that right—the shares are decidedly undervalued. In fact, one would almost have to assume the company were ready to go out of business to still be bearish at this level, and we expect the company to be around for a long time to come. The catalyst for the pummeling wasn’t rotten numbers for the quarter, it was forward guidance. In fact, Chegg’s revenue rose 2% year-over-year, to $202.2 million in the quarter; and adjusted net income rose 8%, to $50.1 million. Earnings per share easily beat the Street’s estimate of $0.24, coming in at $0.32. Finally, subscriber growth—that wonderful, “sticky” revenue stream—rose by 12%. The problems began to appear when management began talking. Claiming that more people were now focusing on “earning over learning,” CEO Dan Rosensweig warned of rough quarters ahead, lowering full-year revenue guidance from the $830M-$850M range to $740M-$770M. Those figures, and a similar reduction in expected earnings, helped the stock crater to a new 52-week low, falling 30% in one day.
Chegg has been aggressively growing its international footprint, offering a direct-to-student learning platform which should continue to increase its market share in a solid industry: education services. While we don’t currently own the company, we believe the shares could easily fetch $35 before long. That would give investors a 100% reward for taking on the risk of owning this small-cap name.
Tu, 04 May 2022
Trading Desk
Opening industrial automation leader within the New Frontier Fund
This current market downturn has been indiscriminate: it has taken some fine companies down to valuations not seen since spring of 2020. We are adding a great but beaten down industrial company to the New Frontier Fund. When you think of automation and the factory of the future, this mid-cap gem should come to mind. Members, log into the Trading Desk for details.
Mo, 01 May 2022
Economics: Goods & Services
Yes, the US economy contracted in the first quarter of the year; but no, it won't become a trend just yet
Technically, a recession is defined as two consecutive quarters of economic contraction within an economy. How concerned should we be, then, that the US economy shrunk by 1.4% in the first quarter? In our opinion, not very. While the headline number is concerning, some comfort can be found by reviewing the internal components of the Commerce Department's report, which was released last week. Government spending actually slowed, which may not be a good thing in the eyes of economists, but in the "real world," it signals at least a modicum of fiscal responsibility. The trade deficit soared in the first quarter on a surge in imports; certainly not a desirable condition, but one which shows the American consumer is still flush with cash and willing to spend. Visualize all of those cargo ships stuck at US ports finally offloading their goods. For all of the concern over inflation, higher prices didn't seem to mute consumer spending last quarter. Fixed investment—economic jargon for the purchase of physical assets such as machinery, land, buildings, and other hard assets—grew a whopping 7.3% in Q1, versus a 2.7% growth rate in the same quarter of last year. Hardly a sign that businesses are buckling down in anticipation of a pending recession. In short, don't expect a consecutive contraction when the Q2 GDP numbers are released in July.
In the past, slowing GDP figures would have certainly played a major role in the Fed's decisions on rates. However, with runaway inflation taking center stage, we still expect a slew of rate hikes this year. By the time the next recession rolls around, probably at some point in 2023, expect more normalized long-term interest rates—which we would anticipate being in the 4.50% range. That is a good thing, as it would give the Fed something to work with should it need to begin loosening once again.
We, 27 Apr 2022
Aerospace & Defense
David Calhoun will never run out of excuses for Boeing's problems; will shareholders ever run out of patience with him?
It was yet another disastrous quarter for formerly-great American aerospace giant Boeing (BA $152). Against underwhelming expectations for $15.9 billion in sales and a $0.15 per share loss, the company brought in just $14 billion in revenue (a 12% decline from the same quarter last year) and had a loss of $2.75 per share (an 80% larger loss than the same quarter last year). Boeing shares proceeded to drop some 14%, to their lowest level since October of 2020, giving the company a smaller market cap than European rival Airbus (EADSY $27) for the first time ever. Even the cash burn was worse than expected, with Boeing blowing through some $3.6 billion versus expectations for a $3 billion cash burn. The company has now missed analysts’ expectations in nine out of the last twelve quarters. Watching hapless CEO David Calhoun being interviewed by CNBC’s Phil LeBeau was painful. With an unsure, shaky voice, he blamed the quarter on everything but the management team—even citing the company’s last Air Force One deal as a reason for the horrible quarter. (If it were so bad, why did you make it?) We knew Calhoun, who was Chairman during the company’s two ill-fated 737-MAX crashes, was the wrong selection for CEO from the start. But he placed himself in the position shortly after telling us how much confidence the board had in then-CEO Dennis Muilenburg. He gave himself the role as the other board members nodded their sycophantic approval like Governor William J. LePetomane’s staff in Blazing Saddles. It should be noted that Calhoun’s compensation last year was $21 million, while the company lost some $4 billion over that time frame. With serious failures on both the aircraft and spacecraft side of the business, when will the madness end?
We sold our BA shares shortly after the second MAX crash—after holding them in one of the Penn portfolios for over a decade. With all the activist investors out there, often going after good management teams, where is the shareholder uprising at Boeing?
Tu, 26 Apr 2022
Random thought: Are we the only ones who find it a bit insincere for investment houses to "adjust" their S&P 500 predictions for the full year? If you are going to change your prediction, why make one in the first place? It is like placing a bet in March on a team to win the Super Bowl, then asking for your money back when October rolls around and your team is 1-4. We made our predictions in December that the S&P 500 would be at 5,100 by the end of the year; wouldn't changing that prediction (which we still stand by) be a bit deceptive?
Tu, 26 Apr 2022
Capital Markets
Fidelity plans to bring cryptocurrencies to your 401(k) plan; we applaud the move
Whatever you may think of Bitcoin, cryptocurrency is now its own asset class and it is here to stay. While this digital money has certainly not shown itself to be a hedge against inflation, nor an inversely correlated (to equities) asset class, it will be of growing importance to the capital markets. That is why we were happy to see Fidelity Investments, a major retirement plan provider, announce plans to include Bitcoin as a core option within its 401(k) plans. It won't be offered as a mutual fund or ETF, such as the Grayscale Bitcoin Trust (GBTC $29), but rather a dedicated asset account just like a plan's money market option. Fidelity would custody the assets on its own digital assets platform, charging between 75 and 90 basis points for administration. Employees' allocation to the crypto portion of their retirement plan would be limited to 20%, though individual employers could place further limitations on that percentage. How big is this move? Of a roughly $8 trillion 401(k) plan market, Fidelity controls approximately $3 trillion of that amount. Expect others to follow the company's lead.
We imagine Jack Bogle, the curmudgeonly old founder of Vanguard, is rolling over in his grave at this news. We recall him once arguing that employees were given too many options in their retirement plans, and that more controls (i.e., limitations) needed to be put in place by the government. Of course, that would have meant more assets under management for his company's less-than-stellar target-date funds.
Mo, 25 Apr 2022
Media & Entertainment
The rise and demise of CNN+ (a 30-day tale)
When we first heard that CNN was going to package a standalone streaming subscription service, our immediate thought was, "subscription overload time." We figured the effort would ultimately fail; we had no idea it would do so in under a month. The Warner Bros. Discovery (WBD $20) creation seemed doomed from the start, based on the fanciful wishes of WarnerMedia's management team to build CNN+ into a digital version of the New York Times. The faulty premise was the (arrogant) notion that millions of cord cutters who had previously viewed CNN as part of their respective cable package would suddenly be willing to subscribe to a standalone CNN news network. They threw out a "conservative" estimate of two million new subscribers by the end of the operation's first year. After all, that was a mere one-third of the six million subscriptions that the Times boasts. (The New York Times actually claims it just passed the ten million paid subscribers mark with its acquisition of The Athletic, but that involves some seriously creative math.) The management team even considered putting a paywall around the entire cnn.com site; as we say, arrogance. When AT&T (T $20) completed its WarnerMedia spin-off more quickly than expected, placing industry veteran David Zaslav at the helm, the end was at hand. We have a lot of respect for Zaslav, who has little tolerance for BS. The dream of milking off of AT&T and its deep pockets (and lack of good financial decision making based on past acquisitions) turned into a nightmare. Immediately after WBD began trading as a standalone, CNN+'s marketing budget was adjusted to zero. Chris Licht, former executive producer of Stephen Colbert's show, had just been brought in to run the new operation. One of his first duties was to tell the staff that the unit was defunct, and that they could try and get reassigned to other departments, but that most would be losing their jobs. Licht, himself, will be looking for other work soon. "This is a uniquely shitty situation," Licht told his stunned audience.
Is AT&T a worthy investment now that they have spun off WarnerMedia? No. Is Warner Bros. Discovery a good investment now that they are a standalone? No.
Fr, 22 Apr 2022
Market Pulse
There are different strains of downturns; investors should not sweat this week's garden variety
Investors are going to have to accept this simple fact: the markets will throw a number of tantrums during the Fed's tightening cycle, despite the irrationality of doing so. Quite often, there are very good reasons for a market selloff. March of 2020's downturn, based on the uncertain nature of a global health threat, was a good reason. When markets are vastly overvalued, like they were in March of 2000, that becomes another good reason for a big drawdown. Sometimes, however, the market sells off for very inane, irrational reasons. Chalk this week's downturn up to the latter. It was another one of those weeks when nothing worked: all of the major equity benchmarks fell, as did gold and oil. Bonds typically go up as equities go down; this past week, headline after headline read: "The Global Bond Market Rout." And it was, indeed, the bond market which drove equities lower. If anyone doesn't expect the Fed to raise rates 50 basis points at the May meeting, they have had their head in the sand. Let's be clear: fear of rate hikes is a really dumb reason for a market selloff. Even if Powell and company raise rates at every single meeting for the next year, we will still be below the historical average. The markets can withstand this course of events, despite the investor fits which will be thrown along the way. Here's why we are actually excited about the coming hikes: we will finally be able to pick up some decent-yielding bonds once again, which will mean stronger portfolio allocations. And at some point in 2023, when the Fed will be forced to reverse course due to a looming recession, those bonds are going to look mighty good sitting in our portfolios.
Tech stocks and small-caps have been hit the hardest this year, with both areas not far away from bear market territory. Scan some of the P/E ratios of strong tech/small-cap holdings; you might be surprised at how cheap they are. Want an example? Coinbase Global (COIN $132), a company we hold in the New Frontier Fund, had a P/E ratio of 172 one year ago; it currently holds a multiple of ten. Bargains abound, just choose wisely.
Fr, 22 Apr 2022
Leisure Equipment, Products, & Facilities
Floundering Peloton has one viable option remaining: get acquired and let the new owner broom the C-suite
We were early investors in Peloton (PTON $20), a company which brought a little life back into the languid fitness products market. We stood by the company when they were being attacked by thin-skinned viewers over a Christmas ad which we found to be highly effective—and not at all offensive. Even with the steep price for its products (the Tread+ was selling for around $5k with warranty), we liked the company's business model. Then, following a tragic accident involving a child as well as scores of other incidents, cracks began to appear in the management team's facade. After briefly trying to go on offense against the feds, Co-Founder and then-CEO John Foley was forced to strike a deal with the Consumer Product Safety Commission (CPSC), agreeing to offer a full refund for the 125,000 or so customers who purchased the pricey tread. Furthermore, the machine could be returned for a full refund at any point in time up until 06 November, 2022.
Since then (the agreement was announced last May), John Foley has stepped down as CEO, but the management missteps continue. As if a $39 monthly fee for the Peloton membership was not enough, the company announced it would be raising prices to $44 this June. Here's the insult to injury part (truly, no pun intended): The company's safety "fix," which was also part of the CPSC agreement, made it virtually impossible to use the tread without a membership! What a stupid move, considering the fact that users now have a full six months to think about that slap-in-the-face before deciding whether or not to get their full refund. Membership prices should have been reduced to $30 per month, and customers who willingly paid out a whopping amount of money should retain the ability to run on their tread without a monthly membership fee. That would have been an easy software fix, but that ship has now sailed.
The only remaining viable option for the company is to court suitors, such as Apple (it would be a great fit), and agree to be acquired. With a market cap of under $7 billion (it was a $50 billion company in January of 2021), that would be a win-win outcome. With an obtuse management team, however, that crystal clear option is probably not even being considered.
When PTON shares fell to $50, we said they may be worth a look—though we did not own them at the time. We obviously underestimated the management team's ability to make dumb decisions. Ultimately, we imagine the company will be backed into a corner and have no choice but to sell—or liquidate. As for us, we will continue paying the confiscatory monthly fees through the summer, then turn that fancy puppy in for a full refund and buy another company's tread. With the leftover dough, maybe we will buy a nice television to hang in front of the device; one that offers more than a single, captive, expensive channel. (For Peloton owners, go here for the CPSC recall info, plus the company's contact info; deadline for full refund is 06 Nov 2022.)
We, 20 Apr 2022
Under the Radar
Lundin Mining Corp (LUN.TO $14)
Lundin Mining Corp is a diversified Canadian base metals miner with operations in the United States, Brazil, Chile, Portugal, and Sweden. Copper production is the company's main source of revenue, with about 70% of last year's sales being generated by the base metal. That being said, gold, zinc, and nickel mining are also important components to the company's continued profitability. Not only do we like the miner's geographic footprint—which steers clear of geopolitical hotspots, we also like its mix of products: copper plays a critical role in electronics, power generation and transmission (especially renewables), industrial machinery, and construction. While the risk level is a bit high (3-year beta 1.750), owning the shares have been worth it (3-year alpha 5.090). Lundin has a strong balance sheet, little debt, and a 3.16% dividend yield for income-oriented investors.
We would place a fair value of $20 on LUN.TO shares; the company is appropriate for investors looking for income, a global commodities play, and a willingness to hold a higher-risk name.
We, 20 Apr 2022
Media & Entertainment
The Netflix nightmare continues: shares plunged 35% in one day
Admittedly, we have never been fans of Netflix (NFLX $218) the stock, which means we have missed out on some stunning growth in the past. It also means, however, that we avoided the 69% plunge in the shares between last November and this week. Unlike activist investor (and someone we like about as much as Netflix stock) Bill Ackman, who made an enormous bet on the company three months ago, buying some 3.1 million shares. A full 35% of the stock's decline occurred on Wednesday, following the release of an awful quarterly earnings report. Instead of gaining subscribers, as the company has done every quarter going back to 2011, Netflix actually lost 200,000 subscribers over the three month period. In guidance which stunned analysts even more than Q1's figures, the company said it now expects to lose two million more subscribers in the second quarter. Analysts had been predicting a pick-up of two million subs in the current quarter. While management pointed to the company's retreat from Russia as one explanation for the drop, we would argue that yet another increase in the subscription rate—to $15.49 per month—certainly drove some customers away. Tesla CEO Elon Musk tweeted his own rationale for the streaming service's troubles: "The woke mind virus is making Netflix unwatchable." As for Ackman, he just sold his 3.1 million shares for a huge short-term loss. At least that should help him at tax time next year.
Following the abysmal results, analysts began lowering their price targets for NFLX shares at breakneck speed. Even after their 69% drop, we still wouldn't touch the shares.
Tu, 19 Apr 2022
Airlines
To the delight of the carriers, federal judge in Florida rules CDC overstepped its bounds with airline mask mandate
On Monday, a federal judge in Florida ruled that the CDC had overstepped its authority when it decreed that masks were required to be worn by all passengers on aircraft and other means of public transportation. Shortly after the judge's ruling, the TSA announced that it would no longer enforce the mandate. By Tuesday, all of the major airlines lifted the requirement. In her ruling, US District Judge Kathryn Kimball Mizelle said that the Centers for Disease Control had failed to adequately give the rationale for its mandate, and did not allow for the normal procedure of public comment before issuing its decree. The United States Department of Justice is reviewing the decision and deciding whether or not it will appeal. In addition to the airlines, Amtrak has officially removed its mask requirement, as has private ride-hailing service Uber (UBER $33).
With vaccines and therapies now available, lifting the mask mandate was the common sense next step in our return to some semblance of normalcy. While many health experts are predicting strains of the disease will re-emerge with force when the weather turns colder this coming fall and winter, we don't see a return of either lockdowns or widespread mask requirements. In other words, the disease has become an endemic which must be managed by the health care system for the foreseeable future. As for the airlines specifically, we expect pent up demand for travel to fuel strong earnings over the coming quarters. We own United Airlines Holdings (UAL $45) in the Penn Global Leaders Club.
Tu, 19 Apr 2022
Capital Markets
Schwab gaps down nearly 9% on earnings miss
Retail financial services firm Charles Schwab (SCHW $76) lost nearly 9% of its value on Monday following a first quarter miss on both revenue and earnings. Analysts were looking for $4.83 billion in revenue and earnings per share of $0.84; instead, they got $4.67 billion in revenue and $0.77 in EPS. While retail activity has surged in recent years on the back of commission-free trading, daily trading volume at the firm actually dropped 22% from the same period last year. Increased volatility, new competition, and a return to normal activities following the pandemic all played a role in the company's challenges for the quarter. As for the earnings miss, the high costs associated with the TD Ameritrade acquisition and higher general expenses helped explain the lackluster quarter. Expenses for the three-month period came in $56 million above what Piper Sandler had projected, and 4% above last year's figures. Monday's drop represents the largest one-day decline in SCHW shares since March of 2020.
The company won't admit it, but the TD Ameritrade acquisition has brought about a good deal of unexpected headaches. These will eventually be worked through, but with its P/E ratio of 27 and its rather high price-to-sales ratio of 8, investors shouldn't be in a hurry to take advantage of this most recent drop in the share price.
Tu, 19 Apr 2022
Latin America
AMLO tried to nationalize Mexico's electrical grid; the lower house of congress short-circuited his plans
The state oil company of Mexico, Pemex, is the most indebted oil company in the world. This makes perfect sense, as it is owned and operated by a government rather than private enterprise. What Mexico accomplished through Pemex, President AMLO had hoped to do for the country's electrical grid: nationalize it. To that end, his allies in the Congress of the Union attempted to push through a bill restoring government control over the electrical sector. Fortunately for the Mexican people, the body's lower house refused to deliver. Needing a two-thirds majority to amend the constitution, only 55% of the lower chamber's members voted for the scheme, handing AMLO a rare legislative defeat. AMLO lashed out, calling critics of the bill betrayers of Mexico and defenders of foreign interests. Considering the bill's passage would have greatly diminished foreign investment in Mexico's energy sector, it sounds like these members were acting in the best interest of the citizenry.
This is yet another example of a country's leadership wishing to have it both ways: they want foreign money but wish to keep full control of the entities. It simply doesn't work that way. One of these days, Mexico will offer a great opportunity for investors. That day won't come, however, until elected officials understand and accept how a free market works. The easiest way to invest in the Mexican economy is through the iShares MSCI Mexico ETF (EWW $53). The fund lost 46% of its value in spring of 2020 during the early days of the pandemic, and has a one-year fund outflow of $518 million, leaving just $900 million in total assets under management.
Economics: Supply, Demand, & Prices
June inflation came in red hot, but the market drop was misguided
On Wednesday the 13th, June’s inflation numbers rolled in. They were expected to be high, but investors discounted the spike and futures were up. Within seconds of the scorching 9.1% year-over-year number being released, futures took a U-turn and tumbled some 400 points on the Dow and 200 points (-1.8%) on the Nasdaq. A 75-basis-point rate hike was already expected for July; after the report, odds of another 75-basis-point hike in September (there is no August FOMC meeting) more than doubled to around 78%. Keeping this in perspective, these two probable hikes would just put the upper limit of the Fed funds rate at 3.25%. For all the comparisons to the 1970s and 1980s, consumers could only dream about such low rates back then. The Fed should—must—make these moves.
As for the market’s immediate reaction, it was misguided. We believe that peak inflation has now hit, and that prices should begin to stabilize. Commodity prices, which have been on a steep trajectory for the past nine months or so, have turned the corner and are now pulling back at a rapid clip. Auto repossessions are exploding as an inordinate number of Americans who purchased vehicles during the pandemic have suddenly stopped making payments. Buyers and renters are pushing back against the high price of homes and 14% increase in leases by holding off on making a move—or, in the case of younger renters, moving back home. Companies of all sizes, expecting a recession, have begun to pull back on capital expenditures. Smaller companies are really feeling the pinch. Forget the American consumer for a moment: if companies start to pull back on spending, inflation will begin to subside.
Copper, a fundamental industrial-use metal, has lost one-third of its value since April. Wheat, corn, and other ag products have also dropped precipitously over the past few months. Even oil has dropped back below the $100 per barrel rate. These are signs that inflation is starting to return to more normal levels. Add a price-wary consumer to the mix, and suddenly the headline narrative begins to deflate, no pun intended. Mild recession or not, the second half of the year could hold some pleasant surprise for investors. At least the ones who resisted the urge to panic.
By “resisting the urge to panic,” we mean sticking to one’s proper portfolio diversification. On that front, we are excited by the Fed’s rate hikes as they signal some great bond issues are on the horizon. In the meantime, investors should remember that cash truly is an asset class, and a 20% allocation to that class is not excessively high right now. Dry powder to take advantage of the coming opportunities.
We, 06 Jul 2022
Airlines & Air Freight
JetBlue just can’t win: FAA awards coveted Newark slots to Spirit alone
Three miles south of downtown Newark and nine short miles from Manhattan lies Newark Liberty International Airport. Serving some 40 million passengers annually prior to the pandemic, the airport remains one of the busiest in the world. Back in 2019, Southwest Airlines (LUV $36) pulled out of the airport due to falling revenue amidst the grounding of Boeing’s (BA $135) 737-MAX fleet. This week, the FAA awarded all sixteen open slots at Newark to low-cost carrier Spirit Airlines (SAVE $25). JetBlue (JBLU $8), which has already been rebuffed twice by Spirit as a takeover target, had also been vying for the slots. A spokesperson for the FAA’s parent organization, the Department of Transportation, said that awarding all slots to Spirit would improve competition and secure more low-cost flights for Newark passengers.
A few weeks ago, JetBlue sweetened its takeover offer for Spirit, offering shareholders $30 at close and $1.50 per share in prepayment (from a raised reverse break-up fee). Spirit’s management team, however, remains committed to Frontier’s (ULCC $10) takeover offer, arguing that the deal will not face the same level of government scrutiny. (They are correct: we don’t see the respective government agencies approving a JetBlue/Spirit merger due to routing and competition issues.) Two major shareholder advisory firms, Glass Lewis and Institutional Shareholder Services (ISS), are now urging approval of the Frontier bid during this month’s shareholder vote.
It is difficult to find any airline we like right now due to inflation, a slow-moving economic slowdown, and chronic flight cancellations. We have one carrier in the Global Leaders Club, United (UAL $37), but we have a tight stop loss order on the shares. As for the airline in the direst straits (in our opinion): we wouldn’t touch shares of JetBlue.
We, 06 Jul 2022
Currencies & Forex
For the first time since 2002, the dollar is reaching parity with the euro
We always found it bizarre that certain politicians and leading economists would express a desire for a weak US dollar. Yes, our lopsided balance of trade can be aided by a weaker domestic currency, as it makes US goods cheaper for the world to buy, but the root causes of this condition are almost always troublesome. Furthermore, it harms the American consumer because their money doesn’t go as far. In essence, it is a signal that “our economy is weaker than yours.” Hardly bragging rights. For example, as the US was in the midst of the Financial Crisis of 2008/09, the euro, which was created in 1999, hit a high of €1.60 to one greenback. Many Europhiles have since predicted that parity would never be reached again. Lo and behold, the two currencies are now skirting near that level right now, with the euro hitting a two-decade low. This is due to the Fed’s willingness to raise rates until inflation is quelled, while the ECB begrudgingly signaled that it would finally raise rates by 25 basis points in July. The responsible actions on the part of the Fed add to the dollar’s strength, as global investors seek safe haven for their lowest-risk assets. While the US will probably have to battle a recession early next year, at least the Fed will have some fresh ammo; not so much the case in Europe, which is facing a deeper economic trough.
US multinational corporations do like a weaker dollar, as it makes their goods cheaper for the world to buy. The best way for an investor to take advantage of a strengthening dollar is through a bullish dollar ETF, such as the Invesco DB US Dollar Bullish fund (UUP $28), or by adjusting their portfolio toward small-cap US companies, most of whom sell overwhelmingly to domestic customers. In this space we use the Invesco S&P SmallCap 600 Revenue ETF (RWJ $103), a value/core fund which owns top revenue-producing smaller US companies.
Fr, 01 Jul 2022
Market Pulse
Worst first half of the year since 1970, but where do we go from here?
There have been a lot of comparisons to the 1970s floating around recently, and for good cause. After all, many of the same antagonists we faced fifty years ago haunt us today: China, Russia, inflation, high oil prices, and general economic malaise. Then there are the market comparisons. Yes, we have just closed out the worst first half of any year for the S&P 500 since 1970, and for the Dow Jones Industrial Average since 1962. Furthermore, the Nasdaq and Russell 2000 (small caps) just had their worst start to a year--ever. Anyone listening to the doom and gloom in the press and among economists certainly don’t feel much like buying. It is as if the all-but-guaranteed recession at our doorstep will mean the end to life as we know it. The negativism is palpable.
As we have recently noted, the entire decade of the 1970s was not kind to the markets; however, it was not just one big ten-year decline for the indexes. After dropping around 25% in the first half of 1970—eerily similar to 2022—the S&P 500 actually gained back nearly all of its losses on the back half, finishing the year down under 1%. While the Nasdaq didn’t come about until 1971, the same could be said of many of its would-be components back then.
At the end of the first half of this year, the S&P, Nasdaq, and Russell 2000 all found themselves in bear market territory, as defined by at least a 20% drop. The Nasdaq got hit the hardest, falling 30%. Bonds, which are supposed to provide a hedge to market losses, dropped 10.7% in aggregate over the past six months. Investors now seem certain on more rate hikes, a recession, terrible corporate earnings, a continuing war in Ukraine, and stubbornly persistent higher oil and gas prices. In other words, the stock market now reflects the worst of all possible outcomes for the second half.
This has created a condition in which large tech names like Microsoft, Apple, Adobe, and Amazon appear as though they are value plays. And large cap core/value names like Dollar General, Target, Pfizer, Home Depot, and Lockheed Martin have multiples that would have made investors drool last summer. All of these companies have rock solid balance sheets and strong fundamentals, it should be noted. The last time we remember solid companies selling off like this was March of 2020. June, it just so happens, was the worst month in the market since (you guessed it) March of 2020. Fear and gloom have taken over. Historically, with respect to equities, that has nearly always been the time to buy; never the time to panic.
Will the second half of the year be an encore to the second half of 1970? While we can’t say for sure, it wouldn’t surprise us a bit. Nonetheless, protection on positions and a larger allocation to cash (as we await higher rates which will lead to better bond values) are certainly prudent measures to maintain right now.
We, 29 Jun 2022
Hotels, Resorts, & Cruise Lines
Morgan Stanley analyst: Carnival Cruise Lines could go to $0 in worst-case scenario
Every time we write about Carnival Corp (CCL $9), we begin with the disclaimer that we have disliked the company and its shares for some time. A year ago, we wrote about members of senior management talking up the company’s great growth prospects while simultaneously offloading their own shares—at a much higher price than they are today, we might add. CCL shares were selling for $19 at the time. Morgan Stanley analysts have apparently had enough as well. The company maintained its “underweight” rating on the stock (why not “sell”?) while lowering the price target to $7. This helped drive the stock down some 15% at the open, to under $9 per share. Even more disconcerting was the analyst’s bear case scenario for the cruise line: the price of the shares could possibly go to $0. The catalyst for that stunningly bearish call is, primarily, the company’s debt load. Carnival holds some $11 billion worth of short-term debt and $32 billion worth of long-term debt. It has a current market cap of $10 billion. Should an upcoming recession trigger another “demand shock,” it could spell the end of the line as the company would find it very difficult to secure even more funding (at higher rates, we might add). Not everyone is so bearish, however. Six of the 24 major analysts covering the stock have a “buy” rating on the shares. Count us in the Morgan Stanley camp.
Both Royal Caribbean (RCL $36) and Norwegian Cruise Lines ($12) fell nearly double digits in sympathy with Carnival on Wednesday. For investors betting on a cruise line comeback, either of those names would offer a much better play on the industry in our opinion. (Penn does not own any cruise lines within the five portfolios.)
We, 29 Jun 2022
Global Organizations & Accords
Obstacle falls: Turkey agrees to full NATO membership for Sweden and Finland
Considering his deranged mental capacity, Vladimir Putin will never admit to the enormous tactical error he made by invading Ukraine, but it is clearly evident to the rest of the world. Based on the false narrative that Ukraine posed a threat to Russia, he invaded with the expectation of killing the country’s leader, Volodymyr Zelenskyy, and installing his own puppet regime. He has obviously failed in that attempt, but the unintended consequences of his barbaric act can be summed up with one stunning development: NATO is coming to Russia’s northwestern doorstep.
The one obstacle holding back Sweden and Finland’s membership into the military alliance was Turkey, which has been in the group since 1952. Based on the group’s bylaws, any expansion required approval by all member-states. Turkey had opposed the Nordic countries’ ambitions to join due to their respective governments’ support for Kurdish “terrorists” allegedly residing within the two nations. Now, according to Turkish President Recep Tayyip Erdogan, those concerns have been assuaged, leaving a clear path toward membership. Erdogan’s announcement came at the alliance’s Madrid Summit, which can now focus on its plan to rebuild forces in Europe to counter the increased Russian threat. That country has threatened to station nuclear weapons along its border with Finland if the nations were admitted to NATO.
Back in the 1990s, following the fall of the Soviet Union, many misguided critics questioned the need for NATO to remain in existence. Today, it is once again as important as it was during the height of the Cold War.
The final straw which ultimately brought about the fall of the Soviet Union was Ronald Reagan’s Strategic Defense Initiative and the communist nation’s attempt to counter the program. History may well repeat itself: Russia is ill-equipped to counter a strengthened NATO on its border, but Putin will spend critical capital trying to do just that.
We, 22 Jun 2022
Municipal Bonds
Alabama finds underwriters for $725 million worth of tax-free prison bonds
Breaking down a rather complicated series of events, here is what is going on in Alabama with respect to the improvement of conditions for prisoners, and the funding of these upgrades. The state faced a lawsuit from the DoJ which alleged that inmates housed in the state’s prisons were being exposed to “cruel and unusual punishment” due to dilapidated conditions. One such building, the Draper Correction Facility, had been in operation since 1939. To answer these concerns, the state contracted with CoreCivic Inc (CXW $12), a specialty REIT, to build and operate newer facilities, leasing them back to the Alabama Department of Corrections.
To fund the projects the state planned to offer municipal bonds, with the debt being backed by annual appropriations to the Department of Corrections. After backlash over the privately built and managed facilities, Barclays Plc and KeyBanc Capital Markets, the primary underwriters, dropped out of the deal. A CoreCivic spokesperson called the activists “reckless and irresponsible” for (apparently) preferring to have inmates remain in the outdated facilities rather than support a public-private enterprise.
Now, the deal has a new set of underwriters: Alabama-based Stephens Inc and The Frazer Lanier Company will co-manage the sale, along with help from Raymond James, Wells Fargo, and several other backers. The bonds will carry an Aa2 rating by Moody’s and a AA- rating by S&P Global. The yield on these tax-free general obligation (GO) bonds has yet to be announced, but they should hit the muni bond marketplace within the next month.
As rates bottomed out and the world was in the midst of the pandemic, there was a dearth of new muni bond issues. While the US faces a probable recession early next year, higher rates and the need to rebuild the American infrastructure should present investors with a huge wave of new tax-free bonds. Who knows, they may even get close to the 5% range many of them offered income-oriented investors back in the early years of the century. We would settle for a 3% tax free rate.
We, 22 Jun 2022
Beverages, Tobacco, & Cannabis
In blow to Altria, the FDA is poised to order Juul e-cigarettes off the market
In a rather stunning turn of events, the Food and Drug Administration is preparing an order that would force Juul Labs to take its popular e-cigarettes off American shelves. This follows a two-year review of the products, specifically the fruit flavored blends. The FDA’s ruling serves as a capstone to the great downfall of Juul, which was flying high back in 2018 as its products soared to the top of a frenzied market. In what turned out to be a critical miscalculation, 2018 also happens to be the year that tobacco giant Altria (MO $41) decided to take a 35% stake in the company. What might have seemed like a reasonable move to diversify away from its traditional cigarette products (Altria owns the popular Marlboro brand, among others), the company bought in at the worst possible time. Shares of MO had been holding up quite well in 2022 thus far, sitting at where they were trading going into the year. As soon as the news was announced, shares fell 10% and remained stuck there. The 2018 deal valued Juul at around $35 billion; just prior to the FDA decision, the company had a valuation of roughly $5 billion. Adding insult to injury, the FDA also indicated that e-cigarettes made by rivals Reynolds American and NJOY Holdings would be allowed to continue selling their tobacco-flavored vaping devices. Juul lost around $259 million on sales of $1.3 billion in 2021.
Somewhat surprisingly, there are still some Altria bulls out there. In addition to a fat 7.88% dividend yield, the company has maintained annual revenues of between $24 billion and $26 billion per year for the past ten years and has generated positive net income in all but one (2019) of those years. We wouldn’t touch the stock, especially considering the firm spun off its international division—Philip Morris International (PM $99)—back in 2008.
Tu, 21 Jun 2022
Currencies & Forex
Japanese yen falls to a 24-year low against the dollar
If you have been considering a Japanese getaway, now might be the time to book that trip. As of this week, one US dollar will buy 135 yen, up from slightly over 100 at the start of the year. Why does the world’s third-most-traded currency continue to plummet? Because the Bank of Japan’s governor, Haruhiko Kuroda, stands firmly by his commitment to maintain a -0.1% short-term interest rate while the rest of the developed world is raising rates to tamp down runaway inflation. Angering the Japanese public with his recent comments that consumers were becoming more tolerant of higher prices, nearly 60% of the country’s residents now find him unfit for the job. A weak currency due to an easy money policy means that goods and services cost a lot more for consumers within that country, and a lot cheaper for foreign visitors thanks to the generous exchange rate. Yes, a weak currency promotes stronger exports because the goods are less expensive for the world to buy, but the tradeoff can be brutal for the family budget. For a country which imports 94% of its energy, soaring prices and a weaker yen have most cheering the fact that Kuroda is in the final year of his second term as governor of the central bank.
For investors, the yen’s weakness also makes the Japanese stock market look more attractive thanks to the currency disparity. One way to potentially take advantage of this weakness is through the WisdomTree Japan Hedged Equity Fund (DXJ $64), which is up 2.35% in value this year against the backdrop of an 18% decline in the MSCI All-Cap World Index, Ex-US. Some of the fund’s top holdings are Toyota Motor Corp, Nintendo, Mitsubishi, and Canon.
Tu, 21 Jun 2022
Food Products
Kellogg to break into three companies; does anybody care?
Five years ago, we wrote a brief piece on Kellogg’s (K $69) hiring of a new CEO after floundering for years under chief executive John Bryant. We expressed doubt that Steven Cahillane would be any different. At the time, K was sitting around $70 per share. Confirming our concerns, the shares have barely budged since.
So, what does a mediocre company do to move the needle on its share price? Announce a plan to split into multiple entities, of course. Sure enough, shares of Kellogg opened the week up nearly 4% after management announced it would break into three pieces: a global snacking company, a North American cereal company, and a plant-based food company, names to be decided at a later date. We are not talking about GM spinning off its financing unit (remember GMAC?) or GE spinning off its jet-leasing unit; we are talking about a food company spinning off…food companies. Aren’t all three units within the core competencies of a packaged food manufacturer?
Right out of the mediocre manager playbook, CEO Cahillane said that the standalone companies will now be able to “direct their resources toward their distinct strategic priorities…and create more value for all stakeholders….” What a bunch of gobbledygook. Milquetoast executives throw out terms like “unlock value” as if a split would magically open corporate treasure chests which the crackerjack team had just been unable to open in the past. Really? All of the talent at your fingertips and you just couldn’t crack the code, but now you will be able to? What will be fun to watch next is how many middling analysts get excited by this move and upgrade the shares. Insert eye roll emoji here.
Full disclosure: We own Kellogg’s chief competitor, General Mills (GIS $68), in the Penn Global Leaders Club.
Th, 09 Jun 2022
Aerospace & Defense
BWX Technologies wins DoD contract to build first advanced microreactor in US
Aerospace & Defense firm BWX Technologies (BWXT $54) has been awarded a contract by the United States Department of Defense to build a first-of-its-kind advanced nuclear microreactor. Under codename Project Pele, these reactors, which can be transported by modules aboard trucks, trains, aircraft, or ship, are designed to be assembled on-site and operational within 72 hours. The reactors can provide a resilient power source for a variety of operational needs, eliminating the need for fossil fuels delivered by often extensive supply lines. The possibilities are endless, from immediate power needs at remote locations, to disaster response and recovery around the world. The prototype will be built under a contract valued at around $300 million and should be completed and delivered by 2024 for multiyear testing at the Idaho National Laboratory.
As we move away from fossil fuels, these advanced concepts are going to come to fruition, and the industry is full of potential going forward. A lack of understanding and a fear of the word “nuclear” may slow the process, but the safety attributes of these devices will eventually allow them to become embraced by politicians and the general population. BWX Technologies is a $5 billion specialty manufacturer and service provider of nuclear components. Additionally, the Lynchburg, Virginia-based firm provides uranium processing, environmental site restoration services, and other solutions to the nuclear power industry. With average annual revenues around $2 billion, the company is perennially profitable.
We, 08 Jun 2022
Renewables
Solar stocks surge on Biden’s decision to hold off on new solar tariffs for two years
Investing in the solar energy movement has always been fraught with danger, with the slightest shift in sentiment or any new legislative (or executive) actions generally causing an oversized reaction by investors in the industry. The latest news on the latter front, however, had solar enthusiasts cheering. The Biden administration announced there would be no new tariffs placed on solar panel imports for the next two years. There had been a major push underway by the US Department of Commerce to investigate whether global solar panel suppliers were using deceptive tactics to avoid getting hit with tariffs on goods emanating from China. That push, along with supply chain constraints, led to a major slowdown in solar panel installation in the US. In a decision we find more impactful on the US economy, the president also signed three executive orders designed to increase domestic production of solar panels. Tesla, which had been in partnership with Panasonic to produce such panels at a Buffalo, New York facility, has since exited the production side of the business and now focuses solely on installation of the systems.
The Invesco Solar ETF (TAN $78) has been on a roller coaster ride this year, dropping 25% before rebounding to flat YTD. The new legislation, along with soaring energy prices, could provide a catalyst for the companies within this fund in the second half of the year. Enphase Energy (ENPH $214) is the largest of the fund’s 42 holdings, with a 12% weighting.
While we do not currently own any direct solar plays in the Penn strategies, we do own Tesla (TSLA $737), a major renewables player and lithium-ion battery manufacturer, in the New Frontier Fund.
We, 01 Jun 2022
Monetary Policy
The Fed will finally start reducing its $9 trillion balance sheet this month
It is hard to imagine, but just nineteen years ago, in 2003, the Federal Reserve had around $700 billion of assets on its balance sheet. That amount, it should be noted, is one component of the national debt. After the financial crisis of 2008-09, the balance sheet more than tripled, hitting $2.25 trillion. At the time, those figures were hard to fathom. Quadruple that amount and we have the current size of the Fed balance sheet. June is the month the figure finally begins going down.
Four large Treasury securities held by the Fed, worth $48.25 billion, are maturing this month. In previous months, the Fed would have reinvested the proceeds, purchasing an equal amount of new securities. Instead, it will let $47.5 billion simply run off the balance sheet, only reinvesting the final $1 billion or so. It will continue this process until September, at which time it will double the amount allowed to mature without reinvestment, reducing the balance sheet by $95 billion per month. This may seem like a rapid pace, but it will only amount to a $522 billion reduction by the end of this year, and an additional $1.1 trillion by the end of 2023. If the downward trajectory continues, the Fed balance sheet will be back to pre-pandemic levels by the summer of 2026.
That date may seem far in the future, but there is something even more unsettling about the entire process: we will probably never get there. The continued reduction is contingent upon the economy humming along between now and June of 2026. Does anyone really believe that yet another “urgent crisis” will fail to manifest? Our best hope is that the balance sheet is reduced by a few trillion dollars before the Fed is forced to go on its next buying spree.
Rarely are two of the Fed’s three main tools used in tandem, at least to this degree: an increase in short-term rates plus a simultaneous reduction of the balance sheet through open market operations. These two actions will undoubtedly have an impact on the housing market specifically, and the overall economy in general. Hence, the doubt expressed by economists that the Fed can execute a “soft landing” as opposed to fomenting a recession. A fascinating case study to watch.
Tu, 31 May 2022
Food & Staples Retailing
The dollar stores provide a much-needed positive catalyst for the markets
Certainly with respect to retailers, it seems all we have been hearing about lately is margin contraction. Consumer Staples companies, which sell the goods people need under all economic conditions, have been maintaining their gross sales levels, but their net profits have shrunk due to higher input, labor, and transportation costs, as well as disruptions in the supply chain. In other words, inflation is killing their bottom line.
Assuming the so-called dollar stores (Dollar General and Dollar Tree primarily) would suffer the same fate at their larger brethren such as Walmart and Target, these companies had their respective share prices hammered in sympathy. All the bad news was priced in before the numbers ever came out. This was true more so for Dollar Tree (DLTR $164), which carries a larger percentage of discretionary items than does Dollar General (DG $228).
Lo and behold, both companies surprised to the upside, sending shares of DG and DLTR up by double digits. Dollar General announced revenue of $8.8 billion, earnings per share of $2.41, and a negligible decline in same-store sales. The company also raised its full year sales guidance and maintained its bottom-line income projections. Dollar Tree posted revenues of $6.9 billion and earnings per share of $2.37, also beating analysts’ predictions, and raised its full year guidance.
How are these low-cost darlings able to withstand inflation better than their larger competitors? Primarily, the answer revolves around management’s effective use of inventory tactics to preserve profits. Dollar General CEO Todd Vasos, for example, explained that the company can shift to substitutes when certain goods go up in price. They have also added self-checkout lanes to over 8,000 stores and have plans to turn another 200 locations into self-checkout only, thus reducing labor costs. For its part, Dollar Tree’s decision to raise the price of its $1 items to $1.25 hasn’t had any detrimental effect on sales. Finally, as could be expected, higher prices are driving more and more Americans to visit these stores; names which they may have shunned in the past. Expect this trend to continue through next year, as the US faces a probable recession.
We have long regarded Dollar General as one of our most defensive plays in the Penn Global Leaders Club. Even after the economy troughs in 2023 or 2024 and begins a new expansion phase, the unique value proposition of the company—such as where the stores are located—means it will probably remain a core holding in the strategy.
We, 25 May 2022
Fintech
AI-powered ETF is facing its first major test, and the results have not been pretty
We recall being intrigued about five years ago when we heard of the AI Powered Equity ETF (AIEQ $32), the so-called robot-managed exchange traded fund. This automated, data-driven fund would “harness the power of IBM Watson to equal a team of 1,000 research analysts, traders, and quants working around the clock.” Using artificial intelligence instead of human brainpower, predictive models would be built on some 6,000 US companies. These models would analyze millions of data points across news, social media, financial statements, and analyst reports to build a more efficient fund. Between 30 and 200 companies with the greatest growth potential over the following twelve months would be purchased, with adjustments being made constantly. Truly a fascinating concept.
It is always a good idea to let concepts prove themselves before jumping in, so we held off on adding AIEQ to the Penn Dynamic Growth Strategy—our ETF portfolio. Watson is certainly an incredibly powerful tool which may enhance a plethora of different industries, but wasn’t it the machine behind our weather app which we were less-than-impressed with? Perhaps Watson could have even predicted how AIEQ would perform in a downturn, but we wanted to find out the old-fashioned way.
Unfortunately, the fund got a chance to prove itself following the worst market start to a year since 1970. Based on the rather impressive breakdown of holdings (roughly an equal representation in Health Care, Industrials, Technology, and Consumer Cyclicals, followed by Financial Services, Consumer Defensives, and Basic Materials companies), the benchmark for the fund would be the S&P 500. While that key market benchmark has given up around 17% year-to-date as of this writing, AIEQ is down 23.84%. We expanded the scope of our comparison to include the Dow Jones Industrial Average (30 holdings), the NASDAQ (primarily tech names), and the Russell 2000 (small-cap proxy). Only the NASDAQ composite, with its 27% loss, underperformed the fund. The narrative was excellent; unfortunately, the results were not. Back to the drawing board.
The Penn Dynamic Growth Strategy (PDGS) is currently comprised of 25 holdings; overwhelmingly ETFs (due to their intraday liquidity, lower general costs, and other factors), and a couple of open-end mutual funds which we rate as exemplary. The Strategy uses a core/satellite approach, with the satellite funds being more tactical in nature (Invesco DBA Agriculture ETF is a great example). The PDGS is actively managed, with changes being made based on the economic, investment, and geopolitical environment.
We, 25 May 2022
Interactive Media & Services
Snap shares just fell 43% in one day; in 2017, we called the company’s share class structure a sham
After social media company Snap (SNAP $13) lowered its outlook for the year—ultimately causing shares of Snapchat’s parent company to fall 43.08% in one day—we immediately began perusing our past notes on the firm. Our first comments came in February of 2017 as the company was about to begin its IPO roadshow. Setting a price target of between $14 and $16 per share, the company would immediately have a $20 billion market cap in what would be the largest US tech offering since Alibaba (BABA $82) went public in 2014. We urged investors not to bite. The roadshow was such a success that the IPO shares were more than ten times oversubscribed. They ultimately priced at $17.
Our next note on Snap came just a month later, in March of 2017. This time we said that investors were getting a raw deal with respect to the share class structure. Get this scheme: The company would sell schmucks like us Class A shares, which came with no voting rights but did “entitle” buyers to attend the annual shareholders’ meeting and “ask questions.” Gee, thanks. Executives of the company could acquire Class B shares, which came with one vote each, while Snap’s founders would own the coveted Class C shares which came with ten votes apiece. Talk about some fancy financial engineering.
The catalysts for our other notes on Snap were earnings reports. In all but one case, shares had plummeted on lower-than-expected numbers or worse-than-expected guidance. The latter was the cause for Tuesday’s 43.08% drop, taking the shares down to $12.79, or 25% lower than the $17 per share initial offering price. What a mess.
SNAP shares now sit 85% off their September 2021 highs. Some might see a bargain; we still see an aristocracy in which the company’s rulers have no idea what they are doing.
Mo, 23 May 2022
Market Pulse
Consumer staples fell dramatically last week, but the Dow is attempting a comeback
If there was one positive sign in this five-month-long anxiety-riddled market tumble, it had been the fact that consumer staples—those stolid, earnings-rich companies that sell goods people need under all economic conditions—were holding their own. That changed last Wednesday after Target (TGT $155) shocked the market with news that profit margins were getting seriously crimped by high inflation—from higher fuel costs to a spike in commodity prices. This exemplary company, which was up around 300% since we added it to the Global Leaders Club, lost one quarter of its value in one day; its worst one-day hit since 1987. And it wasn’t just a Target problem. The prior day, Walmart’s (WMT $122) earnings showed the same challenges, pushing WMT shares down 11%. Ironically (or not), that was also their worst single day since 1987.
We all know what happened in 1987. I was in the US Air Force rather than a cushy chair at an investment firm back then, but I remember the fear being palpable. There really wasn’t a single major catalyst that would explain away the massive market drop, which was part of the problem. Investors feel better if they can point to a viable reason for a system shock, and there wasn’t one in October of 1987 (though there was a confluence of events, much like today). Many investors made the worst possible mistake that month: they began selling even their best positions. Over the course of the next six months or so, the Russell 2000 (small caps) had rallied 37%, the NASDAQ was up 32%, and both the S&P 500 and Dow were up 20%. Those who sold in October missed a remarkable rally right around the corner.
This is not March of 2000. The current bear market much more closely resembles the one which occurred in the fall of 1987. Inflation is real, and the Fed will do what it takes to get it under control (raise rates and reduce the balance sheet), which may push the economy into a mild recession next year. But we wouldn’t be surprised to see the same type of rally occur in the second half of this year that began on 7 December 1987. Friday afternoon and Monday’s follow through may portend that coming rally: the Dow was down over 600 points with a few trading hours left in the week, only to rally into a positive close. That rally continued Monday, with the Dow finishing up 618 points—or more than 1,200 points higher than Friday afternoon’s low. Of course, we have no way of knowing whether the bottom of this current market downturn is in, but it is refreshing to see buyers jumping back in after being pummeled for seven straight weeks.
We, 18 May 2022
Editor's Corner
Don't wave the American flag while watching your cargo ships roll in...
We have preached repeatedly about the irresponsible manner in which so many American companies became overly reliant on a communist nation with respect to trade; how executives became seduced by a massive population for the sale of their goods, and a dirt cheap labor force for the production of those goods. Distressingly, it took a global pandemic originating from that country for many of these companies to (finally) look at reducing their country risk. Still, the narrative these firms weave for public consumption is enough to make us choke.
One major US retailer has a "Made in America" campaign running to proudly proclaim how the goods they sell are made in the US. They use a flower grower as an example. Try finding a flashlight or a can opener at this retailer made anywhere around the globe other than China. You won't.
We are not xenophobes by any stretch, and we still support companies which source from factories in virtually any country outside of China, Russia, North Korea, or Iran. That being said, more can and should be produced domestically. Especially with the Fourth Industrial Revolution at our doorstep, with many American technology firms and universities leading the charge. What can we, as consumers, do to help the process along? We can get in the habit of checking where the goods we buy are actually produced, and providing feedback via direct contact and social media when we don't like what we see.
Tu, 17 May 2022
Construction Materials
Armstrong Flooring paid out $4.8 million in bonuses to execs—then declared bankruptcy
The world of home flooring is one of those murky, opaque realms in which performing due diligence is extremely difficult—often by design. Take, for instance, a home buyer who wants to assure their builder uses wood flooring sourced from anywhere but China. Good luck. The company may be American, and their final products may be designed and even produced in the US, but that doesn’t mean the “cores” of factory-made materials didn’t come from the communist nation. Which leads us to a recent story about Armstrong Flooring (AFI $0.32).
While we couldn’t readily determine what percentage of the company’s wood flooring materials emanated from China, at least they had the courage to admit—clearly on their website—that they do have a flooring plant in the Jiang Su Province of that country—in addition to plants in the US and Australia. We point this out because the company cited supply disruptions and higher transportation costs as two of the reasons it was forced to declare bankruptcy this past week. Never fear, though, as the company fully plans to continue operating while in bankruptcy while it devises plans to emerge. Armstrong told the Delaware court that it owed some $300 million to creditors and has roughly $500 million worth of assets, giving it a debt-to-equity ratio of 61.5%—up from 28.3% in March of 2020 and 17% in September of 2018.
We are happy for the employees of Armstrong, but we must wonder how happy they were to learn that senior executives received some $4.8 million worth of annual incentives just before the company declared bankruptcy; incentives that would have almost certainly been disallowed by the courts. An Armstrong attorney told US Bankruptcy Judge Mary Walrath that these execs (the CEO and at least three others) were key in securing funding, but aren’t the employees key as well? It should be noted that the company’s CEO was the “chief sustainability officer” at Mohawk Industries between 2017 and 2019. It should also be noted that Armstrong had 1,600 employees as of the end of 2021. That $4.8 million would have meant a nice bonus of $3,000 for each, and we will even include the top executives in that package.
We love American free enterprise, which is why we must hold all companies to the highest possible standard. We are not accusing Armstrong of doing anything illegal or even unethical, but companies that wave the American flag and wax eloquent about sustainability had better make sure they are practicing the ethics they preach. The last year Armstrong Flooring turned a profit was 2016, which happens to also be the year that Armstrong World Industries (AWI $84) offloaded the firm as its own publicly traded company, trading in the $19 range. These decisions don’t happen in a vacuum, and it behooves investors to look well beyond the glossy ads and company websites when reviewing a company for possible purchase. Pull up the rug and see what’s underneath, so to speak.
Tu, 17 May 2022
Global Organizations & Accords
Turkey’s objection to Sweden and Finland joining NATO is all about personal gain
Turkey has never been a faithful ally to the West. While desiring to be considered a mainstream Western European country, it has acted in the best interest of the Middle East. While demanding arms from the United States, it gladly accepts a missile defense system from Russia. President Recep Erdogan “massages” the country’s constitution to remain firmly ensconced in power while political opponents are dealt with swiftly and harshly. Now, as two truly European countries, Sweden and Finland, begin their application for formal membership into NATO, Erdogan runs interference, knowing full well that all current members must approve their entry.
Erdogan’s position, as usual, has nothing to do with the common good and everything to do with his own greed and self-enrichment. While claiming that the two Nordic countries need to clamp down on “Kurdish terrorist activities” in the region, he has no problem inciting—or outright approving—terrorist activities at home. Knowing full well that his approval is needed, expect this would-be dictator to successfully milk a host of concessions out of Europe before bestowing his magnanimous blessing on a strengthened NATO. While his good friend Putin won’t be happy with this ultimate decision, Erdogan will have enriched himself, yet again, by playing the dirty merchant of Europe.
On a scale of 1-9 on the democracy meter, Turkey has an abysmal rating of 4.35—more in the proximity of a Russia or a China as opposed to those of its Western neighbors. This won’t change as long as Erdogan is in power, and we don’t see him loosening his grip on that power any time soon.
Tu, 17 May 2022
Airlines
JetBlue is going hostile for Spirit, and it is a complete waste of time
We know how much the big four US-based airlines—American, United, Southwest, and Delta—were financially impacted by the pandemic, and quite understandably so. It follows, then, that the smaller players would be in even rougher shape following the two-year nightmare. Consolidation within the industry among these smaller players makes sense, and we reported this past February of Frontier’s (ULCC $9) plans to acquire Spirit Airlines (SAVE $19) in a deal valued at $2.9 billion ($6.6 billion with debt added in). Another small-cap player, JetBlue (JBLU $10), felt threatened by this move (rightfully so), and made its own offer to buy Spirit for $3.6 billion in an all-cash offer. Interesting, as the market cap of JBLU is just $3 billion. Not seeing a path toward regulatory approval, Spirit said thanks, but no thanks.
Which leads us to JetBlue’s current tactic: going hostile. Denouncing Spirit’s management team for refusing to perform due diligence with its offer, the company said it will actively pressure SAVE shareholders to reject the Frontier bid at a 10 June meeting. Bizarrely, JetBlue said that it would raise its $30 per share offer to $33 per share if management comes back to the table and provides the financial information being requested. That does nothing to alleviate the real problem: we see no circumstances under which the antitrust forces at the Department of Justice and the Federal Trade Commission will allow the JetBlue/Spirit deal to go through. In fact, Spirit CEO Ted Christie has explicitly stated that this may simply be about foiling the Frontier deal. We believe his argument will carry the day with shareholders. A combination of any two of these players would create the country’s fifth-largest airline, leapfrogging over Alaska Air Group (ALK $47).
JetBlue has a host of problems which Spirit wants nothing to do with, to include a worst-in-class, 62% on-time rate. Furthermore, the carrier is already in the Justice Department’s crosshairs, as the agency sued to block the airline’s regional partnership with American Airlines last year. Ultimately, we see the original Frontier acquisition getting approved, which will make JetBlue’s position in the industry even more tenuous.
Mo, 16 May 2022
Aerospace & Defense
Ryanair’s fiery Irish CEO loves Boeing, but “management is a group of headless chickens”
We love CEOs who are true leaders, are interesting characters in their own right, and who don’t feel the need to insert themselves into the political arena to score sycophantic points with super-sensitive stakeholders. Irish low-cost carrier Ryanair’s (RYAAY $81) fiery CEO, Michael “Mick” O’Leary, easily checks all three boxes. When Boeing’s (BA $126) hapless CEO, David Calhoun, is on one of the business networks, we mute the TV to avoid hearing the canned hot air delivered with a strained jumpiness; when we see O’Leary’s face, we always listen with rapt attention. A little background on Ryanair’s history with Boeing: the company has always been one of the aircraft maker’s most loyal customers. A European airliner with a fleet of 471 Boeing aircraft, 145 more on order, and just 29 Airbus (European) aircraft. That made us applaud all the louder when, during a Ryanair earnings call, O’Leary blasted Boeing’s management team and its inability to make good on orders. Saying they need to “bloody well improve on what they’ve been doing…,” he added that, “At the moment, we think the Boeing management (team) is running around like headless chickens.” Hey, that’s just what we have been saying ever since Calhoun anointed himself—with the Board’s blessing—CEO! Hear, hear! How refreshing to have a leader who tells it like it is. We could quickly list a dozen major US companies which could use someone like O’Leary at the helm.
Our minuscule impact on Boeing is limited to not owning it in any of the Penn strategies. We have to believe that the words of a Boeing cheerleader and major customer would have some major sway in the industry. Then again, Boeing has proven itself to be quite tone deaf since Jim McNerney left the firm in 2015, so who knows. It is probably the customer’s fault, right?
Mo, 16 May 2022
East & Southeast Asia
For the US, there was only one direction to go in the Philippines after Duterte
Many of us vividly recall the presidency of Ferdinand Marcos, and the endless stories written by the American press about his wife Imelda’s shoe collection. We thought back to his regime, which ended with a thud in 1986, this past week as his son, Ferdinand “Bongbong” Marcos Jr., notched a landslide election victory to become the next president of the Republic of the Philippines. For the United States, the importance of having a strong ally in this strategically critical region of the world cannot be overstated. Once one of America’s staunchest advocates in Southeast Asia, the country moved decidedly away from its old friend—and toward China—under President Rodrigo Duterte’s six-year rule. Until a last-minute change of heart, in fact, Duterte had all but cut military ties with the US by threatening to end the longstanding Philippines-United States Visiting Forces Agreement (VFA).
Along with the election of Marcos Jr., Filipinos sent a clear message that they do not wish to be subservient to their would-be Chinese masters. Overwhelmingly, voters expressed their unease with Duterte’s cozying up to China’s Xi Jinping. For its part, American military exercises in the South China Sea have enraged China, and the country’s ruling communist party has done everything it could to poison the relationship—not a difficult task with the mercurial Duterte in power. Now, with a huge favorability rating he does not wish to squander, we can expect Marcos to govern in a manner more conducive to overall stability in the region, and that is not what China had been hoping for.
Even though Duterte’s own daughter is the vice president-elect, this election was a clear victory for America’s interests in the region; as much of a victory, in fact, as the March election of Yoon Seok-youl in South Korea. Controlling the South and East China Sea regions are a linchpin to China’s grand ambitions, and the citizens of South Korea and the Philippines have indicated precisely what they think of those plans.
We, 11 May 2022
Automotive
Before a meme stock-like comeback, Carvana shares dropped 92% in nine months
Back in August of last year, used auto platform Carvana (CVNA $30) could do no wrong. Despite a lack of positive net income in any given year over its ten-year history, the company’s sales growth was spectacular, growing from $42 million in 2014 to $11.77 billion in 2021. Investors rewarded the competitor to such names as Carmax (our favorite in the space), Cars.com, and Autotrader by driving CVNA shares up to an intraday high of $376.83 on 10 August 2021. Fast forward precisely nine months, and traders are fleeing the maker of the highly unique Carvana Vending Machines. Shares hit a new 52-week low of $29.13 on the 11th of May after management announced a 12% reduction in its workforce; that price represents a 92% drop from the August highs. Another reason investors soured on the company was news of its acquisition of Adesa US, the wholesale vehicle auction division of KAR Auction Services, for $2.2 billion. Not due the acquisition itself, but the financing scheme: Carvana would be issuing $3.3 billion in junk bonds carrying a yield of 10.25%. In decades gone by, that might seem fine for a junk bond rate; today, it seems too good to be true (for bond buyers). Longtime Carvana investor Apollo Capital Management agreed to secure some $1.6 billion of that paper. As for the layoffs, which equate to roughly 2,500 employees, the company told the SEC that senior management would not collect any salaries for the remainder of the year to help fund the severance packages.
We feel for the investors who bought shares in the company last August. Price targets now range from $40 to $470 among analysts on the Street, but we wouldn’t touch the shares right now—or the 10.25% bonds. The company’s cash burn rate will be hard to sustain, even with the new round of funding.
Fr, 06 May 2022
Week in Review
Despite a hopeful FOMC day, markets suffered their fifth straight week of losses
It would be nice just to focus on Wednesday. Yes, that was the day the FOMC raised rates 50 basis points, the most since May of 2000, but the markets cheered when the Fed Chairman took a 75 basis point rate hike off the table. Between that comment and his belief that the Fed can pull off a “softish” landing, markets took to rallying: the Dow Jones Industrial Average gained 932 points and the NASDAQ rose 3.19%. Unfortunately, there were four other days in the trading week. Like the happy partygoer who wakes up the next day and asks, “what the * was I thinking?” the major benchmarks all made a swift change in directions. The Dow, in fact, shed over 1,000 points for the first time since the spring of 2020. Even a really strong Friday jobs report seemed to irritate the markets. The week’s drop signified the fifth straight down week for the benchmarks, and the worst start to a year since 1970. And that is not a decade we wish to see repeated. We said to expect wild market fluctuations and plenty of volatility during the rate hike cycle, and that certainly manifested itself this past week. The good news? Plenty of great, revenue-generating, industry-dominating American tech giants are now selling at bargain basement valuations. And for the record, we believe investors will be pleased with where the major indexes end the year—especially from the current vantage point.
Fr, 06 May 2022
Under the Radar
Hanesbrands Inc (HBI $12)
I rediscovered Hanes while on a search for socks, t-shirts, and briefs that were actually manufactured somewhere other than China. Sadly, that is a lot harder task that one would assume. In the end, Hanes was the one brand which came shining through. Channeling my inner Peter Lynch, I decided to do a deeper dive into HBI stock. Founded in 1901 and based out of Salem, North Carolina, Hanesbrands includes the Hanes, Champion, Playtex, Maidenform, Bali, and Bonds (Australia) labels. Importantly, this company is vertically integrated: it produces over 70% of its goods in company-controlled factories across some three dozen countries. Unlike a troubling percentage of other American manufacturing firms, it never hitched its wagon to communist-controlled China. In addition to its vertical integration (a major plus considering current supply chain issues), management has successfully created a vibrant omnichannel network. The company sells wholesale to discount, midmarket, department store, and direct to consumer via an impressive online and digital presence. At $12 per share (down from a high of $34.80 and sitting at a 52-week low), this $4.4 billion small-cap value company has a forward P/E of 7.5, a tiny price-to-sales ratio of 0.6520, and a fat dividend yield of 4.72% based on current share price. With a new strategic plan called Full Potential, CEO Steve Bratspies—formerly an Executive Vice President and the Chief Merchandising Officer at Walmart—has a clear vision of where he wants to take the company. We are betting he succeeds. We would conservatively value HBI shares at $24 apiece.
Th, 05 May 2022
Monetary Policy
Fed raises rates most in one meeting since May of 2000; let’s hope the trend continues
In May of 1999, twenty-three years ago this month, the upper limit of the federal funds rate (FFR) was sitting at 4.75%. In an effort to prevent runaway inflation and cool the scorching-hot US economy, the Fed began raising interest rates. It capped that effort one year later, in May of 2000, when it raised rates 50 basis points, from 6% to 6.5%. Why is that history lesson important? Because, to staunch already-runaway inflation, the Fed just made its biggest move since that meeting twenty-two years ago: the Committee spiked rates (upper limit) from 0.50% to 1%. The history lesson also brings home another point. When rates topped out at 6.5%, the central bank had an enormous amount of room to tighten as it worked to avoid recession, which it did (lowering rates) between 2001 and 2003. The accompanying graph provides a wonderful visual for the difference between then and now. Rates must continue to go higher. At the very least, we need to get back to the average FFR of 2.5%. To do so in a timely manner would entail another 50 basis point hike at both the June and July meetings, respectively, and a 25 basis point hike in both September and November. Unless inflation shows real signs of cooling, that is the scenario we can expect to play out. We can also expect a few hikes in 2023, bringing the FFR up to 3% or higher.
In addition to the hike, Fed Chair Jerome Powell also announced a systematic paring back of the Fed balance sheet, which remains just shy of $9 trillion. More perspective: that debt load sat well below $1 trillion back in 2000. Starting in June, that astronomical figure will be reduced by $95 billion per month, equaling a $1.1 trillion reduction by May of 2023. Again, a good start.
With any luck at all, inflation can be tamed without the rate hikes pulling us into a recession until 2024—though the latter scenario may well play out in 2023. The longer we can keep a recession at bay, the more ammo the Fed will have leading into the next tightening cycle.
We, 04 May 2022
Education & Training Services
Textbook company Chegg’s market drop following its earnings release was irrational
Despite the fact that we like Education and Training Services company Chegg (CHGG $17), we knew it was overvalued when the shares were trading north of $100. Now, after falling some 85%—yes, you read that right—the shares are decidedly undervalued. In fact, one would almost have to assume the company were ready to go out of business to still be bearish at this level, and we expect the company to be around for a long time to come. The catalyst for the pummeling wasn’t rotten numbers for the quarter, it was forward guidance. In fact, Chegg’s revenue rose 2% year-over-year, to $202.2 million in the quarter; and adjusted net income rose 8%, to $50.1 million. Earnings per share easily beat the Street’s estimate of $0.24, coming in at $0.32. Finally, subscriber growth—that wonderful, “sticky” revenue stream—rose by 12%. The problems began to appear when management began talking. Claiming that more people were now focusing on “earning over learning,” CEO Dan Rosensweig warned of rough quarters ahead, lowering full-year revenue guidance from the $830M-$850M range to $740M-$770M. Those figures, and a similar reduction in expected earnings, helped the stock crater to a new 52-week low, falling 30% in one day.
Chegg has been aggressively growing its international footprint, offering a direct-to-student learning platform which should continue to increase its market share in a solid industry: education services. While we don’t currently own the company, we believe the shares could easily fetch $35 before long. That would give investors a 100% reward for taking on the risk of owning this small-cap name.
Tu, 04 May 2022
Trading Desk
Opening industrial automation leader within the New Frontier Fund
This current market downturn has been indiscriminate: it has taken some fine companies down to valuations not seen since spring of 2020. We are adding a great but beaten down industrial company to the New Frontier Fund. When you think of automation and the factory of the future, this mid-cap gem should come to mind. Members, log into the Trading Desk for details.
Mo, 01 May 2022
Economics: Goods & Services
Yes, the US economy contracted in the first quarter of the year; but no, it won't become a trend just yet
Technically, a recession is defined as two consecutive quarters of economic contraction within an economy. How concerned should we be, then, that the US economy shrunk by 1.4% in the first quarter? In our opinion, not very. While the headline number is concerning, some comfort can be found by reviewing the internal components of the Commerce Department's report, which was released last week. Government spending actually slowed, which may not be a good thing in the eyes of economists, but in the "real world," it signals at least a modicum of fiscal responsibility. The trade deficit soared in the first quarter on a surge in imports; certainly not a desirable condition, but one which shows the American consumer is still flush with cash and willing to spend. Visualize all of those cargo ships stuck at US ports finally offloading their goods. For all of the concern over inflation, higher prices didn't seem to mute consumer spending last quarter. Fixed investment—economic jargon for the purchase of physical assets such as machinery, land, buildings, and other hard assets—grew a whopping 7.3% in Q1, versus a 2.7% growth rate in the same quarter of last year. Hardly a sign that businesses are buckling down in anticipation of a pending recession. In short, don't expect a consecutive contraction when the Q2 GDP numbers are released in July.
In the past, slowing GDP figures would have certainly played a major role in the Fed's decisions on rates. However, with runaway inflation taking center stage, we still expect a slew of rate hikes this year. By the time the next recession rolls around, probably at some point in 2023, expect more normalized long-term interest rates—which we would anticipate being in the 4.50% range. That is a good thing, as it would give the Fed something to work with should it need to begin loosening once again.
We, 27 Apr 2022
Aerospace & Defense
David Calhoun will never run out of excuses for Boeing's problems; will shareholders ever run out of patience with him?
It was yet another disastrous quarter for formerly-great American aerospace giant Boeing (BA $152). Against underwhelming expectations for $15.9 billion in sales and a $0.15 per share loss, the company brought in just $14 billion in revenue (a 12% decline from the same quarter last year) and had a loss of $2.75 per share (an 80% larger loss than the same quarter last year). Boeing shares proceeded to drop some 14%, to their lowest level since October of 2020, giving the company a smaller market cap than European rival Airbus (EADSY $27) for the first time ever. Even the cash burn was worse than expected, with Boeing blowing through some $3.6 billion versus expectations for a $3 billion cash burn. The company has now missed analysts’ expectations in nine out of the last twelve quarters. Watching hapless CEO David Calhoun being interviewed by CNBC’s Phil LeBeau was painful. With an unsure, shaky voice, he blamed the quarter on everything but the management team—even citing the company’s last Air Force One deal as a reason for the horrible quarter. (If it were so bad, why did you make it?) We knew Calhoun, who was Chairman during the company’s two ill-fated 737-MAX crashes, was the wrong selection for CEO from the start. But he placed himself in the position shortly after telling us how much confidence the board had in then-CEO Dennis Muilenburg. He gave himself the role as the other board members nodded their sycophantic approval like Governor William J. LePetomane’s staff in Blazing Saddles. It should be noted that Calhoun’s compensation last year was $21 million, while the company lost some $4 billion over that time frame. With serious failures on both the aircraft and spacecraft side of the business, when will the madness end?
We sold our BA shares shortly after the second MAX crash—after holding them in one of the Penn portfolios for over a decade. With all the activist investors out there, often going after good management teams, where is the shareholder uprising at Boeing?
Tu, 26 Apr 2022
Random thought: Are we the only ones who find it a bit insincere for investment houses to "adjust" their S&P 500 predictions for the full year? If you are going to change your prediction, why make one in the first place? It is like placing a bet in March on a team to win the Super Bowl, then asking for your money back when October rolls around and your team is 1-4. We made our predictions in December that the S&P 500 would be at 5,100 by the end of the year; wouldn't changing that prediction (which we still stand by) be a bit deceptive?
Tu, 26 Apr 2022
Capital Markets
Fidelity plans to bring cryptocurrencies to your 401(k) plan; we applaud the move
Whatever you may think of Bitcoin, cryptocurrency is now its own asset class and it is here to stay. While this digital money has certainly not shown itself to be a hedge against inflation, nor an inversely correlated (to equities) asset class, it will be of growing importance to the capital markets. That is why we were happy to see Fidelity Investments, a major retirement plan provider, announce plans to include Bitcoin as a core option within its 401(k) plans. It won't be offered as a mutual fund or ETF, such as the Grayscale Bitcoin Trust (GBTC $29), but rather a dedicated asset account just like a plan's money market option. Fidelity would custody the assets on its own digital assets platform, charging between 75 and 90 basis points for administration. Employees' allocation to the crypto portion of their retirement plan would be limited to 20%, though individual employers could place further limitations on that percentage. How big is this move? Of a roughly $8 trillion 401(k) plan market, Fidelity controls approximately $3 trillion of that amount. Expect others to follow the company's lead.
We imagine Jack Bogle, the curmudgeonly old founder of Vanguard, is rolling over in his grave at this news. We recall him once arguing that employees were given too many options in their retirement plans, and that more controls (i.e., limitations) needed to be put in place by the government. Of course, that would have meant more assets under management for his company's less-than-stellar target-date funds.
Mo, 25 Apr 2022
Media & Entertainment
The rise and demise of CNN+ (a 30-day tale)
When we first heard that CNN was going to package a standalone streaming subscription service, our immediate thought was, "subscription overload time." We figured the effort would ultimately fail; we had no idea it would do so in under a month. The Warner Bros. Discovery (WBD $20) creation seemed doomed from the start, based on the fanciful wishes of WarnerMedia's management team to build CNN+ into a digital version of the New York Times. The faulty premise was the (arrogant) notion that millions of cord cutters who had previously viewed CNN as part of their respective cable package would suddenly be willing to subscribe to a standalone CNN news network. They threw out a "conservative" estimate of two million new subscribers by the end of the operation's first year. After all, that was a mere one-third of the six million subscriptions that the Times boasts. (The New York Times actually claims it just passed the ten million paid subscribers mark with its acquisition of The Athletic, but that involves some seriously creative math.) The management team even considered putting a paywall around the entire cnn.com site; as we say, arrogance. When AT&T (T $20) completed its WarnerMedia spin-off more quickly than expected, placing industry veteran David Zaslav at the helm, the end was at hand. We have a lot of respect for Zaslav, who has little tolerance for BS. The dream of milking off of AT&T and its deep pockets (and lack of good financial decision making based on past acquisitions) turned into a nightmare. Immediately after WBD began trading as a standalone, CNN+'s marketing budget was adjusted to zero. Chris Licht, former executive producer of Stephen Colbert's show, had just been brought in to run the new operation. One of his first duties was to tell the staff that the unit was defunct, and that they could try and get reassigned to other departments, but that most would be losing their jobs. Licht, himself, will be looking for other work soon. "This is a uniquely shitty situation," Licht told his stunned audience.
Is AT&T a worthy investment now that they have spun off WarnerMedia? No. Is Warner Bros. Discovery a good investment now that they are a standalone? No.
Fr, 22 Apr 2022
Market Pulse
There are different strains of downturns; investors should not sweat this week's garden variety
Investors are going to have to accept this simple fact: the markets will throw a number of tantrums during the Fed's tightening cycle, despite the irrationality of doing so. Quite often, there are very good reasons for a market selloff. March of 2020's downturn, based on the uncertain nature of a global health threat, was a good reason. When markets are vastly overvalued, like they were in March of 2000, that becomes another good reason for a big drawdown. Sometimes, however, the market sells off for very inane, irrational reasons. Chalk this week's downturn up to the latter. It was another one of those weeks when nothing worked: all of the major equity benchmarks fell, as did gold and oil. Bonds typically go up as equities go down; this past week, headline after headline read: "The Global Bond Market Rout." And it was, indeed, the bond market which drove equities lower. If anyone doesn't expect the Fed to raise rates 50 basis points at the May meeting, they have had their head in the sand. Let's be clear: fear of rate hikes is a really dumb reason for a market selloff. Even if Powell and company raise rates at every single meeting for the next year, we will still be below the historical average. The markets can withstand this course of events, despite the investor fits which will be thrown along the way. Here's why we are actually excited about the coming hikes: we will finally be able to pick up some decent-yielding bonds once again, which will mean stronger portfolio allocations. And at some point in 2023, when the Fed will be forced to reverse course due to a looming recession, those bonds are going to look mighty good sitting in our portfolios.
Tech stocks and small-caps have been hit the hardest this year, with both areas not far away from bear market territory. Scan some of the P/E ratios of strong tech/small-cap holdings; you might be surprised at how cheap they are. Want an example? Coinbase Global (COIN $132), a company we hold in the New Frontier Fund, had a P/E ratio of 172 one year ago; it currently holds a multiple of ten. Bargains abound, just choose wisely.
Fr, 22 Apr 2022
Leisure Equipment, Products, & Facilities
Floundering Peloton has one viable option remaining: get acquired and let the new owner broom the C-suite
We were early investors in Peloton (PTON $20), a company which brought a little life back into the languid fitness products market. We stood by the company when they were being attacked by thin-skinned viewers over a Christmas ad which we found to be highly effective—and not at all offensive. Even with the steep price for its products (the Tread+ was selling for around $5k with warranty), we liked the company's business model. Then, following a tragic accident involving a child as well as scores of other incidents, cracks began to appear in the management team's facade. After briefly trying to go on offense against the feds, Co-Founder and then-CEO John Foley was forced to strike a deal with the Consumer Product Safety Commission (CPSC), agreeing to offer a full refund for the 125,000 or so customers who purchased the pricey tread. Furthermore, the machine could be returned for a full refund at any point in time up until 06 November, 2022.
Since then (the agreement was announced last May), John Foley has stepped down as CEO, but the management missteps continue. As if a $39 monthly fee for the Peloton membership was not enough, the company announced it would be raising prices to $44 this June. Here's the insult to injury part (truly, no pun intended): The company's safety "fix," which was also part of the CPSC agreement, made it virtually impossible to use the tread without a membership! What a stupid move, considering the fact that users now have a full six months to think about that slap-in-the-face before deciding whether or not to get their full refund. Membership prices should have been reduced to $30 per month, and customers who willingly paid out a whopping amount of money should retain the ability to run on their tread without a monthly membership fee. That would have been an easy software fix, but that ship has now sailed.
The only remaining viable option for the company is to court suitors, such as Apple (it would be a great fit), and agree to be acquired. With a market cap of under $7 billion (it was a $50 billion company in January of 2021), that would be a win-win outcome. With an obtuse management team, however, that crystal clear option is probably not even being considered.
When PTON shares fell to $50, we said they may be worth a look—though we did not own them at the time. We obviously underestimated the management team's ability to make dumb decisions. Ultimately, we imagine the company will be backed into a corner and have no choice but to sell—or liquidate. As for us, we will continue paying the confiscatory monthly fees through the summer, then turn that fancy puppy in for a full refund and buy another company's tread. With the leftover dough, maybe we will buy a nice television to hang in front of the device; one that offers more than a single, captive, expensive channel. (For Peloton owners, go here for the CPSC recall info, plus the company's contact info; deadline for full refund is 06 Nov 2022.)
We, 20 Apr 2022
Under the Radar
Lundin Mining Corp (LUN.TO $14)
Lundin Mining Corp is a diversified Canadian base metals miner with operations in the United States, Brazil, Chile, Portugal, and Sweden. Copper production is the company's main source of revenue, with about 70% of last year's sales being generated by the base metal. That being said, gold, zinc, and nickel mining are also important components to the company's continued profitability. Not only do we like the miner's geographic footprint—which steers clear of geopolitical hotspots, we also like its mix of products: copper plays a critical role in electronics, power generation and transmission (especially renewables), industrial machinery, and construction. While the risk level is a bit high (3-year beta 1.750), owning the shares have been worth it (3-year alpha 5.090). Lundin has a strong balance sheet, little debt, and a 3.16% dividend yield for income-oriented investors.
We would place a fair value of $20 on LUN.TO shares; the company is appropriate for investors looking for income, a global commodities play, and a willingness to hold a higher-risk name.
We, 20 Apr 2022
Media & Entertainment
The Netflix nightmare continues: shares plunged 35% in one day
Admittedly, we have never been fans of Netflix (NFLX $218) the stock, which means we have missed out on some stunning growth in the past. It also means, however, that we avoided the 69% plunge in the shares between last November and this week. Unlike activist investor (and someone we like about as much as Netflix stock) Bill Ackman, who made an enormous bet on the company three months ago, buying some 3.1 million shares. A full 35% of the stock's decline occurred on Wednesday, following the release of an awful quarterly earnings report. Instead of gaining subscribers, as the company has done every quarter going back to 2011, Netflix actually lost 200,000 subscribers over the three month period. In guidance which stunned analysts even more than Q1's figures, the company said it now expects to lose two million more subscribers in the second quarter. Analysts had been predicting a pick-up of two million subs in the current quarter. While management pointed to the company's retreat from Russia as one explanation for the drop, we would argue that yet another increase in the subscription rate—to $15.49 per month—certainly drove some customers away. Tesla CEO Elon Musk tweeted his own rationale for the streaming service's troubles: "The woke mind virus is making Netflix unwatchable." As for Ackman, he just sold his 3.1 million shares for a huge short-term loss. At least that should help him at tax time next year.
Following the abysmal results, analysts began lowering their price targets for NFLX shares at breakneck speed. Even after their 69% drop, we still wouldn't touch the shares.
Tu, 19 Apr 2022
Airlines
To the delight of the carriers, federal judge in Florida rules CDC overstepped its bounds with airline mask mandate
On Monday, a federal judge in Florida ruled that the CDC had overstepped its authority when it decreed that masks were required to be worn by all passengers on aircraft and other means of public transportation. Shortly after the judge's ruling, the TSA announced that it would no longer enforce the mandate. By Tuesday, all of the major airlines lifted the requirement. In her ruling, US District Judge Kathryn Kimball Mizelle said that the Centers for Disease Control had failed to adequately give the rationale for its mandate, and did not allow for the normal procedure of public comment before issuing its decree. The United States Department of Justice is reviewing the decision and deciding whether or not it will appeal. In addition to the airlines, Amtrak has officially removed its mask requirement, as has private ride-hailing service Uber (UBER $33).
With vaccines and therapies now available, lifting the mask mandate was the common sense next step in our return to some semblance of normalcy. While many health experts are predicting strains of the disease will re-emerge with force when the weather turns colder this coming fall and winter, we don't see a return of either lockdowns or widespread mask requirements. In other words, the disease has become an endemic which must be managed by the health care system for the foreseeable future. As for the airlines specifically, we expect pent up demand for travel to fuel strong earnings over the coming quarters. We own United Airlines Holdings (UAL $45) in the Penn Global Leaders Club.
Tu, 19 Apr 2022
Capital Markets
Schwab gaps down nearly 9% on earnings miss
Retail financial services firm Charles Schwab (SCHW $76) lost nearly 9% of its value on Monday following a first quarter miss on both revenue and earnings. Analysts were looking for $4.83 billion in revenue and earnings per share of $0.84; instead, they got $4.67 billion in revenue and $0.77 in EPS. While retail activity has surged in recent years on the back of commission-free trading, daily trading volume at the firm actually dropped 22% from the same period last year. Increased volatility, new competition, and a return to normal activities following the pandemic all played a role in the company's challenges for the quarter. As for the earnings miss, the high costs associated with the TD Ameritrade acquisition and higher general expenses helped explain the lackluster quarter. Expenses for the three-month period came in $56 million above what Piper Sandler had projected, and 4% above last year's figures. Monday's drop represents the largest one-day decline in SCHW shares since March of 2020.
The company won't admit it, but the TD Ameritrade acquisition has brought about a good deal of unexpected headaches. These will eventually be worked through, but with its P/E ratio of 27 and its rather high price-to-sales ratio of 8, investors shouldn't be in a hurry to take advantage of this most recent drop in the share price.
Tu, 19 Apr 2022
Latin America
AMLO tried to nationalize Mexico's electrical grid; the lower house of congress short-circuited his plans
The state oil company of Mexico, Pemex, is the most indebted oil company in the world. This makes perfect sense, as it is owned and operated by a government rather than private enterprise. What Mexico accomplished through Pemex, President AMLO had hoped to do for the country's electrical grid: nationalize it. To that end, his allies in the Congress of the Union attempted to push through a bill restoring government control over the electrical sector. Fortunately for the Mexican people, the body's lower house refused to deliver. Needing a two-thirds majority to amend the constitution, only 55% of the lower chamber's members voted for the scheme, handing AMLO a rare legislative defeat. AMLO lashed out, calling critics of the bill betrayers of Mexico and defenders of foreign interests. Considering the bill's passage would have greatly diminished foreign investment in Mexico's energy sector, it sounds like these members were acting in the best interest of the citizenry.
This is yet another example of a country's leadership wishing to have it both ways: they want foreign money but wish to keep full control of the entities. It simply doesn't work that way. One of these days, Mexico will offer a great opportunity for investors. That day won't come, however, until elected officials understand and accept how a free market works. The easiest way to invest in the Mexican economy is through the iShares MSCI Mexico ETF (EWW $53). The fund lost 46% of its value in spring of 2020 during the early days of the pandemic, and has a one-year fund outflow of $518 million, leaving just $900 million in total assets under management.
Th, 14 Apr 2022
Flagship vessel of the Russian Black Sea fleet, the missile cruiser Moskva (Moscow), has been so badly damaged that the crew has been forced to evacuate. At least, it is out of commission; at most, it will sink into the Black Sea. Yet again, Putin has overestimated his military and underestimated the adroitness and resolve of the Ukrainians.
UPDATE: It sunk. Russia (falsely) claims ammo exploded on the vessel; Ukraine (correctly) explains that its Neptune missiles successfully struck and destroyed the Moskva.
Th, 14 Apr 2022
The Twitter board views Musk's takeover offer as a distraction. Distraction from what? Losing money? That seems to be their strongest skillset. As for the prince from Saudi Arabia "rejecting" Musk's offer, his sovereign wealth fund owns roughly half as many TWTR shares as Musk. I would create a competing platform and take my 80 million followers (we are among them) to a better platform. As for Twitter's supposed "poison pill" to keep Musk at bay, considering their debt load and the amount of money they are losing, it appears they have already deployed it.
Th, 14 Apr 2022
Trading Desk
Opening new international semiconductor play in the New Frontier Fund
As the world continues to ween itself off of semiconductors made in China, this European company should benefit nicely. It provides thousands of products to companies in industries such as telecom, automotive, industrials, and consumer products. And yes, Tesla is a customer. See the Trading Desk for details.
Flagship vessel of the Russian Black Sea fleet, the missile cruiser Moskva (Moscow), has been so badly damaged that the crew has been forced to evacuate. At least, it is out of commission; at most, it will sink into the Black Sea. Yet again, Putin has overestimated his military and underestimated the adroitness and resolve of the Ukrainians.
UPDATE: It sunk. Russia (falsely) claims ammo exploded on the vessel; Ukraine (correctly) explains that its Neptune missiles successfully struck and destroyed the Moskva.
Th, 14 Apr 2022
The Twitter board views Musk's takeover offer as a distraction. Distraction from what? Losing money? That seems to be their strongest skillset. As for the prince from Saudi Arabia "rejecting" Musk's offer, his sovereign wealth fund owns roughly half as many TWTR shares as Musk. I would create a competing platform and take my 80 million followers (we are among them) to a better platform. As for Twitter's supposed "poison pill" to keep Musk at bay, considering their debt load and the amount of money they are losing, it appears they have already deployed it.
Th, 14 Apr 2022
Trading Desk
Opening new international semiconductor play in the New Frontier Fund
As the world continues to ween itself off of semiconductors made in China, this European company should benefit nicely. It provides thousands of products to companies in industries such as telecom, automotive, industrials, and consumer products. And yes, Tesla is a customer. See the Trading Desk for details.
Mo, 18 Apr 2022
Global Organizations & Accords
Putin, his own worst enemy, is pushing historically-neutral Finland and Sweden into the arms of a welcoming NATO
While Norway has been a member of NATO since its inception in 1949, neighboring Nordic countries Sweden and Finland have historically and steadfastly remained nonaligned with any military organization or group. It appears that is all about to change. Especially with respect to Finland, which borders Russia to its east, it is easy to understand this geopolitical balancing act. For Finnish Prime Minister Sanna Marin, however, "Everything changed when Russia invaded Ukraine." Prime Minister Magdalena Andersson of Sweden was just as succinct with her analysis: "There is a before and after the 24th of February." Both women lead countries on the verge of deciding whether or not to apply for NATO membership, with its "an invasion of one is an invasion of all" canon. Finland has paved its path toward membership with a new security-policy report clearly outlining the threat posed by its eastern neighbor. For the fiercely-independent citizens of both countries, Putin's aggressive actions have had a clear impact, with majorities now favoring membership. With decisions from both countries imminent, the autocratic leader of Russia has already issued an ultimatum. Dmitry Medvedev, once Putin's puppet president and now the country's prime minister, has said that a nuclear-free Baltic region would no longer be possible if Finland and Sweden become NATO member-states. Lithuanian Prime Minister Ingrida Simonyte dismissed the threats, noting that Russia has already armed the region with nuclear weapons. The death and destruction brought about by the invasion has been a tragedy for Europe and for the civilized world. At least it appears to be crystallizing the resolve of Europe to a rare degree.
We would put money on Finland and Sweden joining the alliance, which will lead to more saber-rattling by Putin. We applaud the leadership being exercised in the region, which will certainly manifest itself through larger defense budgets.
Global Organizations & Accords
Putin, his own worst enemy, is pushing historically-neutral Finland and Sweden into the arms of a welcoming NATO
While Norway has been a member of NATO since its inception in 1949, neighboring Nordic countries Sweden and Finland have historically and steadfastly remained nonaligned with any military organization or group. It appears that is all about to change. Especially with respect to Finland, which borders Russia to its east, it is easy to understand this geopolitical balancing act. For Finnish Prime Minister Sanna Marin, however, "Everything changed when Russia invaded Ukraine." Prime Minister Magdalena Andersson of Sweden was just as succinct with her analysis: "There is a before and after the 24th of February." Both women lead countries on the verge of deciding whether or not to apply for NATO membership, with its "an invasion of one is an invasion of all" canon. Finland has paved its path toward membership with a new security-policy report clearly outlining the threat posed by its eastern neighbor. For the fiercely-independent citizens of both countries, Putin's aggressive actions have had a clear impact, with majorities now favoring membership. With decisions from both countries imminent, the autocratic leader of Russia has already issued an ultimatum. Dmitry Medvedev, once Putin's puppet president and now the country's prime minister, has said that a nuclear-free Baltic region would no longer be possible if Finland and Sweden become NATO member-states. Lithuanian Prime Minister Ingrida Simonyte dismissed the threats, noting that Russia has already armed the region with nuclear weapons. The death and destruction brought about by the invasion has been a tragedy for Europe and for the civilized world. At least it appears to be crystallizing the resolve of Europe to a rare degree.
We would put money on Finland and Sweden joining the alliance, which will lead to more saber-rattling by Putin. We applaud the leadership being exercised in the region, which will certainly manifest itself through larger defense budgets.
Mo, 11 Apr 2022
E-Commerce
We are fine with Shopify's ten-for-one stock split decision; it is the other planned move which has us concerned
Ten-for-one stock splits have been the financial activity du jour for tech companies recently, with the likes of Amazon, Google, and Tesla undertaking such moves. E-commerce platform Shopify (SHOP $601) just joined the pack. We began seriously looking at this e-commerce platform, which is a hugely popular choice for small- and medium-sized businesses wishing to expand their digital footprint, after its share price plunged some 70% in the four-month period between last November and this past March. Around $600 per share, it seems undervalued. The company just announced a move we fully support: it will undergo a ten-for-one stock split, which would bring the current share price to around $60. At first, share futures rallied on the news; but then, another announcement was made which gave investors pause for concern. A new share class would be created, the Founder share, which would be given to founder and CEO Tobi Lutke in order to increase his voting power in excess of 40%. We have made clear our disdain for dual share class structures (or more than dual in many cases), which is little short of financial engineering designed to give elite stakeholders power over us ordinary shlub owners, the hoi polloi who dare to expect some modicum of power simply because we put our hard-earned money into an ownership stake. Granted, Lutke has been a fine—even dynamic—leader for the firm, but he is well compensated for his skills through a generous, $15 million per year pay structure and a 6.27% ownership stake. If he wants so much power over the firm he began, shouldn't he take it private? Shopify really is an excellent platform for small- and mid-sized businesses, but the competition is too keen for the company to turn off would-be investors with this scheme.
We put together the accompanying graph in February, asking if shares were undervalued at $657. If they were then, they certainly are now, with shares floating around the $600 level. Still, we are having trouble accepting this Founder share class maneuver. For investors who have a high risk appetite and are comfortable with the move, we could easily make the argument that the shares are worth between $750 and $1,000. We just can't justify pulling the trigger right now.
E-Commerce
We are fine with Shopify's ten-for-one stock split decision; it is the other planned move which has us concerned
Ten-for-one stock splits have been the financial activity du jour for tech companies recently, with the likes of Amazon, Google, and Tesla undertaking such moves. E-commerce platform Shopify (SHOP $601) just joined the pack. We began seriously looking at this e-commerce platform, which is a hugely popular choice for small- and medium-sized businesses wishing to expand their digital footprint, after its share price plunged some 70% in the four-month period between last November and this past March. Around $600 per share, it seems undervalued. The company just announced a move we fully support: it will undergo a ten-for-one stock split, which would bring the current share price to around $60. At first, share futures rallied on the news; but then, another announcement was made which gave investors pause for concern. A new share class would be created, the Founder share, which would be given to founder and CEO Tobi Lutke in order to increase his voting power in excess of 40%. We have made clear our disdain for dual share class structures (or more than dual in many cases), which is little short of financial engineering designed to give elite stakeholders power over us ordinary shlub owners, the hoi polloi who dare to expect some modicum of power simply because we put our hard-earned money into an ownership stake. Granted, Lutke has been a fine—even dynamic—leader for the firm, but he is well compensated for his skills through a generous, $15 million per year pay structure and a 6.27% ownership stake. If he wants so much power over the firm he began, shouldn't he take it private? Shopify really is an excellent platform for small- and mid-sized businesses, but the competition is too keen for the company to turn off would-be investors with this scheme.
We put together the accompanying graph in February, asking if shares were undervalued at $657. If they were then, they certainly are now, with shares floating around the $600 level. Still, we are having trouble accepting this Founder share class maneuver. For investors who have a high risk appetite and are comfortable with the move, we could easily make the argument that the shares are worth between $750 and $1,000. We just can't justify pulling the trigger right now.
Tu, 05 Apr 2022
Economic Outlook
The yield curve is inverted once again, so does that really mean a recession is rapidly approaching?
The "normal" yield curve makes sense: an investor expects to receive better compensation for longer maturity instruments, as uncertainty understandably increases with time. So, a 5-year Treasury should pay more than a 2-year, a 10-year Treasury should pay more than a 5-year, and so on. This is known as the risk premium—investors expect to be rewarded for taking more risk by going further out on the time horizon. The yield curve inverts when something unusual happens: shorter-maturity instruments begin offering a better yield than their longer-term counterparts, with the difference being known as the spread. The most common comparison economists look at for an indication of economic health is the 2-10 year spread, and it just so happens that the spread in question has inverted.
Why would fixed-income investors be willing to accept a 2.42% rate on a 10-year Treasury right now as opposed to a 2.43% rate on a 2-year? Because they believe that economic conditions will worsen to the point at which the Fed must begin easing in the not-too-distant future. If events unfold in this manner, the value of that 10-year, 2.42% note will rise in value quicker (or at least hold up better) than its shorter-term counterpart. It may seem crazy to be talking about easing when we are just one, 25-basis-point hike into a tightening cycle expected to last a year or so, but that is where we are. As for the time frame, the last five recessions (not counting the one induced by COVID in early 2020) came between 10 and 34 months after the yield curve inverted. This has many economists looking out to mid- to late-2023 for the next one.
Others are splashing cold water on this prognosis, pointing out that foreign demand for 10-year US Treasuries has been elevated and sustained. Per the laws of supply and demand, the issuer—the US government in this case—is able to offer lower rates and still attract buyers. Another factor is duration of the inverted curve. While it has fluttered between negative and positive, there has yet to be a persistent inversion. Throwing a third factor into the mix, the S&P 500 has historically been strong in the period between inversion of the yield curve and the beginning of a recession. In other words, don't panic just yet.
Not counting 2020's mini recession induced by the pandemic, the US has endured twelve recessions since the end of World War II, with the last occurring between 2007 and 2009. It is too simple to say we are "due" a recession, as so many variables conspire to cause the event. Nonetheless, proper asset allocation is paramount when preparing for the next economic downturn—whenever it comes.
Economic Outlook
The yield curve is inverted once again, so does that really mean a recession is rapidly approaching?
The "normal" yield curve makes sense: an investor expects to receive better compensation for longer maturity instruments, as uncertainty understandably increases with time. So, a 5-year Treasury should pay more than a 2-year, a 10-year Treasury should pay more than a 5-year, and so on. This is known as the risk premium—investors expect to be rewarded for taking more risk by going further out on the time horizon. The yield curve inverts when something unusual happens: shorter-maturity instruments begin offering a better yield than their longer-term counterparts, with the difference being known as the spread. The most common comparison economists look at for an indication of economic health is the 2-10 year spread, and it just so happens that the spread in question has inverted.
Why would fixed-income investors be willing to accept a 2.42% rate on a 10-year Treasury right now as opposed to a 2.43% rate on a 2-year? Because they believe that economic conditions will worsen to the point at which the Fed must begin easing in the not-too-distant future. If events unfold in this manner, the value of that 10-year, 2.42% note will rise in value quicker (or at least hold up better) than its shorter-term counterpart. It may seem crazy to be talking about easing when we are just one, 25-basis-point hike into a tightening cycle expected to last a year or so, but that is where we are. As for the time frame, the last five recessions (not counting the one induced by COVID in early 2020) came between 10 and 34 months after the yield curve inverted. This has many economists looking out to mid- to late-2023 for the next one.
Others are splashing cold water on this prognosis, pointing out that foreign demand for 10-year US Treasuries has been elevated and sustained. Per the laws of supply and demand, the issuer—the US government in this case—is able to offer lower rates and still attract buyers. Another factor is duration of the inverted curve. While it has fluttered between negative and positive, there has yet to be a persistent inversion. Throwing a third factor into the mix, the S&P 500 has historically been strong in the period between inversion of the yield curve and the beginning of a recession. In other words, don't panic just yet.
Not counting 2020's mini recession induced by the pandemic, the US has endured twelve recessions since the end of World War II, with the last occurring between 2007 and 2009. It is too simple to say we are "due" a recession, as so many variables conspire to cause the event. Nonetheless, proper asset allocation is paramount when preparing for the next economic downturn—whenever it comes.
Mo, 04 Apr 2022
Interactive Media & Services
Twitter rockets higher after Elon Musk takes 9% stake in the social media platform
A few weeks ago, Elon Musk took to Twitter (TWTR $50) to throw some shade the company's way. After calling the social media platform the "de facto public town square (for the exchange of ideas)," he asked his 80 million followers, "Do you believe Twitter rigorously adheres to this principle (of free speech)?" For the record, the response was 70% to 30% in the negative. Several months before positing this question, Musk tweeted an altered image of CEO Parag Agrawal seemingly doing away with founder and former CEO Jack Dorsey by pushing him into a river. Our opinion is that the tweet was more of a joke than anything (it was funny), but analysts began questioning whether he had it out for Twitter's new boss. On Monday came the news that, around mid March, Musk had made himself the firm's largest shareholder, with a 9% stake worth around $3 billion. News of the stake sent TWTR shares rocketing 27% higher—to $50—in Monday's session. While his position is classified as a passive stake per his 13G filing, it is hard to imagine Musk making his first major investment in a publicly-traded company (outside of one which he controls) without having a say in how the company is managed going forward. Especially given his record of tweeting what is on his mind. The simple fact that he is the largest shareholder gives him more sway over the company than The Vanguard Group or Morgan Stanley Investment Management—the second and third largest shareholders, respectively. The interesting questions become, what will he do with this power, how might (his chronic nemesis) the SEC respond, and what are his larger designs? Stay tuned.
With Twitter shares still down nearly 40% from their highs, even after the Musk bounce, is the platform a buying opportunity? To say we weren't fans of Jack Dorsey would be an understatement, but we have about as much confidence in Agrawal as Musk seems to place in him. Perhaps this new shareholder can be the catalyst the company needs to better monetize its business and actually become the "de facto public town square for the exchange of ideas." Until Musk's plans are a little more clear, we still wouldn't be buyers.
Interactive Media & Services
Twitter rockets higher after Elon Musk takes 9% stake in the social media platform
A few weeks ago, Elon Musk took to Twitter (TWTR $50) to throw some shade the company's way. After calling the social media platform the "de facto public town square (for the exchange of ideas)," he asked his 80 million followers, "Do you believe Twitter rigorously adheres to this principle (of free speech)?" For the record, the response was 70% to 30% in the negative. Several months before positing this question, Musk tweeted an altered image of CEO Parag Agrawal seemingly doing away with founder and former CEO Jack Dorsey by pushing him into a river. Our opinion is that the tweet was more of a joke than anything (it was funny), but analysts began questioning whether he had it out for Twitter's new boss. On Monday came the news that, around mid March, Musk had made himself the firm's largest shareholder, with a 9% stake worth around $3 billion. News of the stake sent TWTR shares rocketing 27% higher—to $50—in Monday's session. While his position is classified as a passive stake per his 13G filing, it is hard to imagine Musk making his first major investment in a publicly-traded company (outside of one which he controls) without having a say in how the company is managed going forward. Especially given his record of tweeting what is on his mind. The simple fact that he is the largest shareholder gives him more sway over the company than The Vanguard Group or Morgan Stanley Investment Management—the second and third largest shareholders, respectively. The interesting questions become, what will he do with this power, how might (his chronic nemesis) the SEC respond, and what are his larger designs? Stay tuned.
With Twitter shares still down nearly 40% from their highs, even after the Musk bounce, is the platform a buying opportunity? To say we weren't fans of Jack Dorsey would be an understatement, but we have about as much confidence in Agrawal as Musk seems to place in him. Perhaps this new shareholder can be the catalyst the company needs to better monetize its business and actually become the "de facto public town square for the exchange of ideas." Until Musk's plans are a little more clear, we still wouldn't be buyers.
Tu, 29 Mar 2022
Real Estate Management & Development
Following a pandemic-driven office exodus, One World Trade Center is bucking the trend with its 95% occupancy rate
Despite what big-city politicians are telling us about the great worker return of 2022, the pandemic—and subsequent advances in telecom technology—helped generate a seismic shift in the corporate real estate environment. Companies which never gave a thought to allowing any of their employees to work remotely have suddenly embraced the hybrid, home/office work model. As financial managers gaze at their leases, which continue to become more costly thanks to inflation, they are even more inclined to change their ways. On top of this transformation, many big financial firms have been fleeing NYC for greener pastures in Florida, despite the fact that the self-proclaimed socialist mayor (DeBlasio) is finally gone. Even as COVID-19 cases continue to subside, the city is still facing 40-year high vacancy rates.
Against that backdrop, we have One World Trade Center, the 104-story "tallest building in the Western Hemisphere." After an existing tenant, Germany's Celonis (data processing), expanded its footprint to the entire 70th floor of the building, the skyscraper is now at 95% occupancy. Considering its 3.1 million square feet of space garners some $75 to $85 per rentable square foot, that is impressive. Breaking that down, and assuming Celonis is paying $80 per square foot, that comes to $3.28 million per year for the 70th floor alone.
With additional space hitting the market, and with financial firms still pulling out, we can expect a dichotomy to form between the high-tech, glass-imbued modern skyscrapers and the clusters of older, less energy efficient buildings in need of constant repair and renovation. The older buildings also lack many of the amenities and features workers are looking for today, including state-of-the-art gyms, plenty of large windows, higher ceiling heights, and outdoor spaces. In many cases, it is structurally impossible to transform a 1970s-era building into one which can compete with its newly-built counterparts. And that will continue to be a major source of consternation for landlords and office property REITs relying on contract renewals and a steady stream of new tenants.
While many office property REITs will struggle with the new hybrid work model, investors should remember that this is an industry full of opportunities in areas outside of office and retail space. Digital Realty Trust (DLR $144), for example, owns and operates 300 data centers worldwide. American Tower Corp (AMT $250) is a specialty REIT which owns a quarter of a million cell towers around the world. Both of these companies are members of the Penn Global Leaders Club.
Real Estate Management & Development
Following a pandemic-driven office exodus, One World Trade Center is bucking the trend with its 95% occupancy rate
Despite what big-city politicians are telling us about the great worker return of 2022, the pandemic—and subsequent advances in telecom technology—helped generate a seismic shift in the corporate real estate environment. Companies which never gave a thought to allowing any of their employees to work remotely have suddenly embraced the hybrid, home/office work model. As financial managers gaze at their leases, which continue to become more costly thanks to inflation, they are even more inclined to change their ways. On top of this transformation, many big financial firms have been fleeing NYC for greener pastures in Florida, despite the fact that the self-proclaimed socialist mayor (DeBlasio) is finally gone. Even as COVID-19 cases continue to subside, the city is still facing 40-year high vacancy rates.
Against that backdrop, we have One World Trade Center, the 104-story "tallest building in the Western Hemisphere." After an existing tenant, Germany's Celonis (data processing), expanded its footprint to the entire 70th floor of the building, the skyscraper is now at 95% occupancy. Considering its 3.1 million square feet of space garners some $75 to $85 per rentable square foot, that is impressive. Breaking that down, and assuming Celonis is paying $80 per square foot, that comes to $3.28 million per year for the 70th floor alone.
With additional space hitting the market, and with financial firms still pulling out, we can expect a dichotomy to form between the high-tech, glass-imbued modern skyscrapers and the clusters of older, less energy efficient buildings in need of constant repair and renovation. The older buildings also lack many of the amenities and features workers are looking for today, including state-of-the-art gyms, plenty of large windows, higher ceiling heights, and outdoor spaces. In many cases, it is structurally impossible to transform a 1970s-era building into one which can compete with its newly-built counterparts. And that will continue to be a major source of consternation for landlords and office property REITs relying on contract renewals and a steady stream of new tenants.
While many office property REITs will struggle with the new hybrid work model, investors should remember that this is an industry full of opportunities in areas outside of office and retail space. Digital Realty Trust (DLR $144), for example, owns and operates 300 data centers worldwide. American Tower Corp (AMT $250) is a specialty REIT which owns a quarter of a million cell towers around the world. Both of these companies are members of the Penn Global Leaders Club.
Tu, 29 Mar 2022
Aerospace & Defense
Lockheed Martin scores two big wins in one month as both Canada and Germany select the company's fighters
Aerospace giant Lockheed Martin (LMT $430) remains one of our strongest conviction holdings for a number of reasons: leadership, geopolitical tensions, style profile, product mix, and growth potential just to name a few. This month we received a couple of other reasons to appreciate this undervalued gem. A few weeks ago Germany, under new Chancellor Olaf Scholz, announced it would be purchasing 35 of the company's F-35 Lightning II "Panther" fighter aircraft to replace its aging fleet of Tornado combat aircraft—a European-built fighter which has been in service since the early 1980s. This was a slap in the face to France, which had argued for a next-generation, European-built fighter to be the focus of the continent's air defenses. This past week, Lockheed beat out yet another European aerospace company as Canada announced it would buy 88 F-35s instead of Saab's (Sweden) Gripen fighters. Boeing had previously been knocked out of the competition. There is some humor in this story, as Saab had complained about a "politically influenced" decision by Finland to buy 64 F-35s, with the company "looking forward to an impartial Canada (to select the Gripen over the Panther)." The Canadian deal alone could equate to an additional $1 billion per year in sales for Lockheed beginning in 2025. The company should consider sending Putin a thank you card for awakening the Western world to the real and present danger of an aggressive Russia and its communist neighbor to the south.
While Boeing flounders under the arrogant leadership of David Calhoun, Lockheed CEO (and former Air Force pilot) Jim Taiclet pushes quietly forward, gaining market share and building bridges to our NATO allies. Leadership matters.
Aerospace & Defense
Lockheed Martin scores two big wins in one month as both Canada and Germany select the company's fighters
Aerospace giant Lockheed Martin (LMT $430) remains one of our strongest conviction holdings for a number of reasons: leadership, geopolitical tensions, style profile, product mix, and growth potential just to name a few. This month we received a couple of other reasons to appreciate this undervalued gem. A few weeks ago Germany, under new Chancellor Olaf Scholz, announced it would be purchasing 35 of the company's F-35 Lightning II "Panther" fighter aircraft to replace its aging fleet of Tornado combat aircraft—a European-built fighter which has been in service since the early 1980s. This was a slap in the face to France, which had argued for a next-generation, European-built fighter to be the focus of the continent's air defenses. This past week, Lockheed beat out yet another European aerospace company as Canada announced it would buy 88 F-35s instead of Saab's (Sweden) Gripen fighters. Boeing had previously been knocked out of the competition. There is some humor in this story, as Saab had complained about a "politically influenced" decision by Finland to buy 64 F-35s, with the company "looking forward to an impartial Canada (to select the Gripen over the Panther)." The Canadian deal alone could equate to an additional $1 billion per year in sales for Lockheed beginning in 2025. The company should consider sending Putin a thank you card for awakening the Western world to the real and present danger of an aggressive Russia and its communist neighbor to the south.
While Boeing flounders under the arrogant leadership of David Calhoun, Lockheed CEO (and former Air Force pilot) Jim Taiclet pushes quietly forward, gaining market share and building bridges to our NATO allies. Leadership matters.
F-35 Lightning II "Panther"; Image courtesy of Lockheed Martin
Mo, 28 Mar 2022
Automotive
With one announcement, and in one session, Tesla gains more in value than Ford Motor Company is worth
Ahh the law of large numbers. It is one thing to say that Tesla (TSLA $1,091) has a market cap of $1.128 trillion versus Ford Motor Company's (F $17) $66 billion, but let's compare their respective sizes with this stunning fact: Tesla's one day change in value is greater than Ford's total value. The reason for the EV maker's 8% gain on the day? The company announced it would perform another stock split to make the shares more accessible to retail investors. Shareholders still need to approve the move, but that is almost a given, and we can assume another 5-1 division is in the works, as was the case with the 2020 split. Speaking of that past event, it led to a 40% rally by Tesla shares and an inclusion in the S&P 500 by year's end.
Just as we liked both Google and Amazon's 20-1 stock split, we like this move as well. Of course, the act of splitting a stock doesn't add or subtract one penny of value in and of itself, but it generally garners excitement by the investment community. This is as opposed to GE's financial engineering in which eight shares suddenly became one share, eight times more expensive. That stunt back in the Summer of 2020 has led to an 11% drop in the almost two years since it happened. We own Tesla in the Penn New Frontier Fund, where it continues to perform as expected. Naysayers point to the flood of EVs about to inundate the market; we point to Tesla's growing lead over the pack, and their massive lead in the world of fuel cell technology.
Automotive
With one announcement, and in one session, Tesla gains more in value than Ford Motor Company is worth
Ahh the law of large numbers. It is one thing to say that Tesla (TSLA $1,091) has a market cap of $1.128 trillion versus Ford Motor Company's (F $17) $66 billion, but let's compare their respective sizes with this stunning fact: Tesla's one day change in value is greater than Ford's total value. The reason for the EV maker's 8% gain on the day? The company announced it would perform another stock split to make the shares more accessible to retail investors. Shareholders still need to approve the move, but that is almost a given, and we can assume another 5-1 division is in the works, as was the case with the 2020 split. Speaking of that past event, it led to a 40% rally by Tesla shares and an inclusion in the S&P 500 by year's end.
Just as we liked both Google and Amazon's 20-1 stock split, we like this move as well. Of course, the act of splitting a stock doesn't add or subtract one penny of value in and of itself, but it generally garners excitement by the investment community. This is as opposed to GE's financial engineering in which eight shares suddenly became one share, eight times more expensive. That stunt back in the Summer of 2020 has led to an 11% drop in the almost two years since it happened. We own Tesla in the Penn New Frontier Fund, where it continues to perform as expected. Naysayers point to the flood of EVs about to inundate the market; we point to Tesla's growing lead over the pack, and their massive lead in the world of fuel cell technology.
Sa, 26 Mar 2022
Beverages, Tobacco, & Cannabis
Tilray Brands gains 55% for the week on positive cannabis news, deal with competitor
A major reason why we added Canadian cannabis player Tilray Brands (TLRY $9) to the Intrepid Trading Platform was its management team: CEO Irwin Simon is the adroit businessman who founded Hain Celestial back in 1993. While the industry's performance has been lacking as of late, to put it mildly, the company had a big turn of luck this past week. First, it announced an alliance with smaller rival Hexo (HEXO $0.74) in which it would help the company straighten out its finances in return for a generous share of the company. Tilray made a similar deal with California-based cannabis player MedMen last year (though the terms of that deal are more convoluted, as a Canadian cannabis firm cannot own a stake in a US-based one as of yet). The market approved of the company's "white knight" approach, pushing shares higher. Then came news that the US House of Representatives would consider a bill to decriminalize marijuana on a national level. Of course, there is no guarantee this one will make it further than previous bills, but it feels as if the movement is getting closer to the finish line. Shares of Tilray rose 55.35% on the week.
We own TLRY in the Intrepid with an initial target price of $14 per share. We expect to see major consolidation in the industry, with Tilray becoming one of the industry leaders. Tilray merged with larger industry player Aphria back in December of 2020.
Beverages, Tobacco, & Cannabis
Tilray Brands gains 55% for the week on positive cannabis news, deal with competitor
A major reason why we added Canadian cannabis player Tilray Brands (TLRY $9) to the Intrepid Trading Platform was its management team: CEO Irwin Simon is the adroit businessman who founded Hain Celestial back in 1993. While the industry's performance has been lacking as of late, to put it mildly, the company had a big turn of luck this past week. First, it announced an alliance with smaller rival Hexo (HEXO $0.74) in which it would help the company straighten out its finances in return for a generous share of the company. Tilray made a similar deal with California-based cannabis player MedMen last year (though the terms of that deal are more convoluted, as a Canadian cannabis firm cannot own a stake in a US-based one as of yet). The market approved of the company's "white knight" approach, pushing shares higher. Then came news that the US House of Representatives would consider a bill to decriminalize marijuana on a national level. Of course, there is no guarantee this one will make it further than previous bills, but it feels as if the movement is getting closer to the finish line. Shares of Tilray rose 55.35% on the week.
We own TLRY in the Intrepid with an initial target price of $14 per share. We expect to see major consolidation in the industry, with Tilray becoming one of the industry leaders. Tilray merged with larger industry player Aphria back in December of 2020.
Sa, 26 Mar 2022
Market Pulse
Thanks to a few good weeks, the ugly quarter is starting to look brighter
When the month hit its midway point, things weren't looking good for the stock market. By session close on Friday the 11th, the S&P 500 had fallen 12% and the NASDAQ was still hanging around bear market territory for the year, down 18%. At that point, investors had little to look forward to: the war in Ukraine was raging—along with inflation in the US—and the Fed was suddenly talking about seven consecutive rate hikes. In the midst of all the worry and few positive catalysts, the major benchmarks strung together two impressive weeks. With just four trading days remaining in Q1, the S&P 500 is off less than 5% for the year, while the NASDAQ and Russell 2000 (small caps) are only off by single digits. This flurry of positive activity took place as bonds continued to lose ground as Treasury yields rose. The 10-year is now yielding just shy of 2.5%—a 15% increase from where it started the week. That spike is understandable considering talk is now swirling around 50-basis-point rate hikes instead of the formerly-baked-in 25 bps. As the real yield on money markets is still deeply in the red thanks to inflation, and as bond values continue to drop due to the tightening cycle we are (finally) in, US equities seem to be the beneficiary. Even cryptos punched their way out of a deep recent funk, with ethereum and bitcoin jumping 10% and 8% on the week, respectively. We are sticking with our year-end target of 5,100 for the S&P 500, which would represent a 12% gain from here. Our year-end target for the upper band of the Fed funds rate is 2%, or 1.5% higher than its current rate. We also expect the Fed to begin substantially lowering its $9T balance sheet by selling some of the $2.6 trillion worth of mortgage-backed securities and Treasuries it holds—or, at least, letting existing ones fall off the balance sheet without reinvesting the proceeds. The market should be able to handle these moves, but expect some tantrums along the way.
Sa, 26 Mar 2022
Under the Radar
Silgan Holdings Inc (SLGN $46)
There are some points in the market cycle at which it pays to be loaded up with boring old defensive plays; the companies that quietly churn out profits, growing their top line revenue and earnings per share quarter after quarter. There is a strong argument being made that the Fed will have to raise rates so rapidly to tame inflation that it will push the US into recession by some point in 2023. If that is the case, now is the time to load up on such companies. For instance: Silgan ("SEAL gun") Holdings (SLGN $46) manufactures roughly half of all metal food containers in North America, with customers such as Campbell Soup, Nestle, and Del Monte. An astute acquirer, the company is currently searching for opportunities to increase its footprint in the European metal and plastic packaging market. Based out of Stamford, Connecticut, this small-cap value gem has a market cap of $5 billion, a forward P/E ratio of 12, and a relative strength rating of 86. We would place a fair value on SLGN shares at $65.
Th, 24 Mar 2022
Media & Entertainment
Trouble in the House of Mouse: Steer clear of Disney due to Iger's ego, Chapek's inability, workers' activism
So many companies we thought would always have a role in the Penn portfolios, so many disappointments. General Electric, Boeing, Starbucks...Disney. The latter, The Walt Disney Company (DIS $138), is now facing a serious crisis of confidence swirling around its leadership team. First we have Bob Iger, the golden CEO who spent fifteen years running the company. Iger was the central figure in the transformation of Disney into the world's largest media company. Unfortunately, the only thing greater than his ability was—and is—his stratospheric ego. After reading his autobiography, The Ride of a Lifetime, the first thing that came to mind was, "Strong leader, complete a**." Perhaps it was Iger's ego—his desire to go out on top—that led him to resign his role as CEO at the worst possible time: just as businesses were shutting down due to the pandemic. It was bad enough that his hand-picked successor, Disney Parks President Bob Chapek, had to receive a baptism by fire, but Iger's refusal to ride off into the sunset compounded the problem. Just a few months after Chapek took the helm, Iger was loudly announcing his plans to help lead Disney through this troubled period. What a punk move. As could be expected, Chapek was furious. That incident caused the couple to become estranged.
To be clear, we were never happy with Iger's pick of Chapek. We felt he was a capable manager, but not the leader Disney would need for its next two decades of growth. That is becoming clear in his handling of what should be a non-issue for the company. As is increasingly the case in America, employees are demanding their companies, the entities which place money in these employees' respective bank accounts, make political stands. Companies should be, by nature, apolitical. That level of corporate maturity doesn't fit into the zeitgeist of today's "pay attention to me!" society, apparently. When the Florida legislature took up a bill which would disallow schools from discussing sexual orientation in grades kindergarten through third, there was a call to arms by certain groups. The fact that Disney would not immediately denounce the bill put them in the crosshairs. In no way, shape, or form did the company come out in support of the bill, it should be noted. Employees were called upon to walk off the job and protest in front of Disney headquarters—iPhone cameras at the ready, no doubt. Chapek quickly did a mea culpa and came out against the bill. The obligatory "listening tour" and "equality task force" quickly manifested.
Before this latest "incident" (which never should have been an incident at all), Chapek made some questionable moves. By picking a fight with Black Widow star Scarlett Johansson—a fight he ultimately lost—he risked alienating the Hollywood community. By centralizing budget control (P&L power) for all movie and TV deals to a key ally, he alienated high level managers in the field who previously held a good deal of such authority. By snubbing Iger instead of stroking his giant ego until he was ultimately out the door, he forced company executives to choose sides. (Iger had remained on as chairman of the board after stepping down as CEO.) None of these were wise moves by a CEO whose contract is up for renewal in eleven months. Disney will weather this latest storm, but something tells us many more are to follow.
In a way we almost feel bad for Chapek, who clearly does not have Iger's charm-on-demand. Furthermore, his strategic vision for the company and its digital future make a lot of sense, but he cannot seem to make the personal connections needed to drive that point home. When Chapek was first announced by Iger as his hand-picked replacement, we sold our Disney stake. That was a wise move, and one we don't plan on reversing until the storm clouds hovering above the Magic Kingdom show signs of subsiding.
Market Pulse
Thanks to a few good weeks, the ugly quarter is starting to look brighter
When the month hit its midway point, things weren't looking good for the stock market. By session close on Friday the 11th, the S&P 500 had fallen 12% and the NASDAQ was still hanging around bear market territory for the year, down 18%. At that point, investors had little to look forward to: the war in Ukraine was raging—along with inflation in the US—and the Fed was suddenly talking about seven consecutive rate hikes. In the midst of all the worry and few positive catalysts, the major benchmarks strung together two impressive weeks. With just four trading days remaining in Q1, the S&P 500 is off less than 5% for the year, while the NASDAQ and Russell 2000 (small caps) are only off by single digits. This flurry of positive activity took place as bonds continued to lose ground as Treasury yields rose. The 10-year is now yielding just shy of 2.5%—a 15% increase from where it started the week. That spike is understandable considering talk is now swirling around 50-basis-point rate hikes instead of the formerly-baked-in 25 bps. As the real yield on money markets is still deeply in the red thanks to inflation, and as bond values continue to drop due to the tightening cycle we are (finally) in, US equities seem to be the beneficiary. Even cryptos punched their way out of a deep recent funk, with ethereum and bitcoin jumping 10% and 8% on the week, respectively. We are sticking with our year-end target of 5,100 for the S&P 500, which would represent a 12% gain from here. Our year-end target for the upper band of the Fed funds rate is 2%, or 1.5% higher than its current rate. We also expect the Fed to begin substantially lowering its $9T balance sheet by selling some of the $2.6 trillion worth of mortgage-backed securities and Treasuries it holds—or, at least, letting existing ones fall off the balance sheet without reinvesting the proceeds. The market should be able to handle these moves, but expect some tantrums along the way.
Sa, 26 Mar 2022
Under the Radar
Silgan Holdings Inc (SLGN $46)
There are some points in the market cycle at which it pays to be loaded up with boring old defensive plays; the companies that quietly churn out profits, growing their top line revenue and earnings per share quarter after quarter. There is a strong argument being made that the Fed will have to raise rates so rapidly to tame inflation that it will push the US into recession by some point in 2023. If that is the case, now is the time to load up on such companies. For instance: Silgan ("SEAL gun") Holdings (SLGN $46) manufactures roughly half of all metal food containers in North America, with customers such as Campbell Soup, Nestle, and Del Monte. An astute acquirer, the company is currently searching for opportunities to increase its footprint in the European metal and plastic packaging market. Based out of Stamford, Connecticut, this small-cap value gem has a market cap of $5 billion, a forward P/E ratio of 12, and a relative strength rating of 86. We would place a fair value on SLGN shares at $65.
Th, 24 Mar 2022
Media & Entertainment
Trouble in the House of Mouse: Steer clear of Disney due to Iger's ego, Chapek's inability, workers' activism
So many companies we thought would always have a role in the Penn portfolios, so many disappointments. General Electric, Boeing, Starbucks...Disney. The latter, The Walt Disney Company (DIS $138), is now facing a serious crisis of confidence swirling around its leadership team. First we have Bob Iger, the golden CEO who spent fifteen years running the company. Iger was the central figure in the transformation of Disney into the world's largest media company. Unfortunately, the only thing greater than his ability was—and is—his stratospheric ego. After reading his autobiography, The Ride of a Lifetime, the first thing that came to mind was, "Strong leader, complete a**." Perhaps it was Iger's ego—his desire to go out on top—that led him to resign his role as CEO at the worst possible time: just as businesses were shutting down due to the pandemic. It was bad enough that his hand-picked successor, Disney Parks President Bob Chapek, had to receive a baptism by fire, but Iger's refusal to ride off into the sunset compounded the problem. Just a few months after Chapek took the helm, Iger was loudly announcing his plans to help lead Disney through this troubled period. What a punk move. As could be expected, Chapek was furious. That incident caused the couple to become estranged.
To be clear, we were never happy with Iger's pick of Chapek. We felt he was a capable manager, but not the leader Disney would need for its next two decades of growth. That is becoming clear in his handling of what should be a non-issue for the company. As is increasingly the case in America, employees are demanding their companies, the entities which place money in these employees' respective bank accounts, make political stands. Companies should be, by nature, apolitical. That level of corporate maturity doesn't fit into the zeitgeist of today's "pay attention to me!" society, apparently. When the Florida legislature took up a bill which would disallow schools from discussing sexual orientation in grades kindergarten through third, there was a call to arms by certain groups. The fact that Disney would not immediately denounce the bill put them in the crosshairs. In no way, shape, or form did the company come out in support of the bill, it should be noted. Employees were called upon to walk off the job and protest in front of Disney headquarters—iPhone cameras at the ready, no doubt. Chapek quickly did a mea culpa and came out against the bill. The obligatory "listening tour" and "equality task force" quickly manifested.
Before this latest "incident" (which never should have been an incident at all), Chapek made some questionable moves. By picking a fight with Black Widow star Scarlett Johansson—a fight he ultimately lost—he risked alienating the Hollywood community. By centralizing budget control (P&L power) for all movie and TV deals to a key ally, he alienated high level managers in the field who previously held a good deal of such authority. By snubbing Iger instead of stroking his giant ego until he was ultimately out the door, he forced company executives to choose sides. (Iger had remained on as chairman of the board after stepping down as CEO.) None of these were wise moves by a CEO whose contract is up for renewal in eleven months. Disney will weather this latest storm, but something tells us many more are to follow.
In a way we almost feel bad for Chapek, who clearly does not have Iger's charm-on-demand. Furthermore, his strategic vision for the company and its digital future make a lot of sense, but he cannot seem to make the personal connections needed to drive that point home. When Chapek was first announced by Iger as his hand-picked replacement, we sold our Disney stake. That was a wise move, and one we don't plan on reversing until the storm clouds hovering above the Magic Kingdom show signs of subsiding.
We, 23 Mar 2022
Fixed Income Desk
Looking to bonds to help protect your portfolio from a market downturn? You may want to take a closer look
We've talked extensively on this subject, but to reiterate: the days of a passive, 60/40 mix of stocks to bonds have passed. Yet another argument for professional money management as opposed to buying a generic mixed basket of Vanguard funds and believing your portfolio is safe. With inflation surging, and with the Fed finally sending in the troops (via rate hikes and a planned balance sheet reduction), the global bond market is in the midst of its largest drawdown on record. How bad is it? The Bloomberg Global Aggregate Index is the benchmark for measuring the universe of fixed income vehicles, to include government, corporate, mortgage-backed, and other debt instruments from both developed and emerging markets. That index is now sitting at a peak-to-trough drawdown of over 11%. In dollar terms, that equates to a loss of over $2.5 trillion. For perspective, during the drawdown brought on by the financial meltdown of 2008-09, the bond market lost roughly $2 trillion of value. With the Fed signaling a total of seven rate hikes this year alone, fixed income investors know full well that they will be able to get a better yield on bonds purchased next year, hence the drop in value of current bond holdings. For further evidence, consider the yield on the 10-year Treasury note, which moves in the opposite direction of bond values. The 10-year now offers a yield of 2.381%, which represents a 57% increase over the 1.514% rate it offered going into 2022. Why wouldn't bond investors keep their money safe and sound in cash until they can get an even better rate? This in spite of the fact that their cash bucket has a current real yield (i.e., adjusted for inflation) of around -7.5%. It's tough being a conservative investor right now.
When selecting fixed income vehicles for our clients, the first metric we look at is duration—a representation of how sensitive the instrument is to changes in interest rates. The lower the duration, the less the vehicle will be affected by rising rates. Right now, we prefer fixed income investments with a duration of five or less. For example, one of our strongest recommendations right now is the SPDR Blackstone Senior Loan ETF (SRLN $45), which has a yield of 4.55% and a tiny duration of 0.301.
Fixed Income Desk
Looking to bonds to help protect your portfolio from a market downturn? You may want to take a closer look
We've talked extensively on this subject, but to reiterate: the days of a passive, 60/40 mix of stocks to bonds have passed. Yet another argument for professional money management as opposed to buying a generic mixed basket of Vanguard funds and believing your portfolio is safe. With inflation surging, and with the Fed finally sending in the troops (via rate hikes and a planned balance sheet reduction), the global bond market is in the midst of its largest drawdown on record. How bad is it? The Bloomberg Global Aggregate Index is the benchmark for measuring the universe of fixed income vehicles, to include government, corporate, mortgage-backed, and other debt instruments from both developed and emerging markets. That index is now sitting at a peak-to-trough drawdown of over 11%. In dollar terms, that equates to a loss of over $2.5 trillion. For perspective, during the drawdown brought on by the financial meltdown of 2008-09, the bond market lost roughly $2 trillion of value. With the Fed signaling a total of seven rate hikes this year alone, fixed income investors know full well that they will be able to get a better yield on bonds purchased next year, hence the drop in value of current bond holdings. For further evidence, consider the yield on the 10-year Treasury note, which moves in the opposite direction of bond values. The 10-year now offers a yield of 2.381%, which represents a 57% increase over the 1.514% rate it offered going into 2022. Why wouldn't bond investors keep their money safe and sound in cash until they can get an even better rate? This in spite of the fact that their cash bucket has a current real yield (i.e., adjusted for inflation) of around -7.5%. It's tough being a conservative investor right now.
When selecting fixed income vehicles for our clients, the first metric we look at is duration—a representation of how sensitive the instrument is to changes in interest rates. The lower the duration, the less the vehicle will be affected by rising rates. Right now, we prefer fixed income investments with a duration of five or less. For example, one of our strongest recommendations right now is the SPDR Blackstone Senior Loan ETF (SRLN $45), which has a yield of 4.55% and a tiny duration of 0.301.
Mo, 21 Mar 2022
Trading Desk
Closed out a big pharma company in Global Leaders to make room for a Materials play
We have a strict rule of only carrying 40 great companies in our Penn Global Leaders Club, so when an addition is made, it must take the place of another. In this case, we let our GlaxoSmithKline (GSK $43) go. Actually, to give it more room for potential growth, we closed it from the strategy and simply placed a $40 stop loss on client positions to preserve double-digit gains. To see our undervalued "Materials: Specialty Chemicals" pick up, clients and members can check out the Penn Trading Desk.
Mo, 21 Mar 2022
East & Southeast Asia
Victory for the US and the Western world: South Korea's surprise election results equal a stronger ally in the region
It was a white-knuckler of a race, but when the dust settled South Korea had a new leader. Few expected Yoon Suk-yeol of the Conservative People Power Party to pull off the upset victory, but his win represents the growing angst in South Korea over Kim Jong-un's incessant saber-rattling and China's growing threat to the stability of the region. It also points to the failure of North Korea's decades-long policy of subterfuge; a policy which involves planting false stories and placing North Korean spies in the country to foment a distrust of the government. It has always been Kim Jong-un's (and his father, Kim Jong-il's) master plan to reunite the peninsula not in the name of peace, but in the name of communist rule. Yoon Suk-yeol's victory has splashed cold water on those plans. Not only has this charismatic leader spoken out against the rampant human rights violations in North Korea and China, he has also made it clear that he wants his country to become a "global pivotal state" on the world stage for the cause of freedom. Such language is anathema to Xi Jingping and his dear friend Kim Jong-un. Yoon's victory means he will lead the fourth-largest economy in Asia for at least the next five years. Over that period of time, we can expect much warmer relations between the US and South Korea, a demand that North Korea give up its nuclear ambitions as a basis for negotiations, and an upgrade to the US THAAD anti-missile system in the country—a system which China vehemently opposes. China and North Korea will seek to undermine his rule in every way imaginable, but something tells us this former prosecutor (of nearly three decades) is up for the task.
The pandemic hit South Korea hard, with the country's GDP shrinking by 1% in 2020 before rebounding to 4% in 2021—an eleven-year high. There are three main ETFs to take advantage of South Korea's explosive potential. The Direxion Daily South Korea Bull 3X ETF (KORU $18) we would steer clear of unless conviction is very strong (due to its triple leverage). The Franklin FTSE South Korea ETF (FLKR $25) is run by—in our opinion—the best global investment team in the world (Franklin). and the iShares MSCI South Korea ETF (EWY $71) is the largest, with $4.5 billion AUM. Our personal choice? Go with the Franklin name, FLKR. In addition to Samsung, Kia, Hyundai, and LG, the fund is full of names which few would recognize—hence the importance of the management team.
Fr, 18 Mar 2022
Media & Entertainment
AMC, the movie we can't pull ourselves away from, just took another odd twist: it bought a debt-laden, floundering gold mine
We have always rooted for underdog AMC Entertainment (AMC $16), although our support began to erode when China's Dalian Wanda Group became controlling owner, and further when CEO Adam Aron remained in his hometown of Philly to run the Leawood, Kansas-based theater chain. We can almost picture the images that popped into the head of the Harvard grad when he found out where it was headquartered. Probably cornfields and rolling tumbleweeds. But, as the likes of Radio Shack, Toys R Us, and Borders (books) began succumbing to the march of time, we really wanted AMC to survive. Of course, we all know what happened next. When the AMC apes first began moving the share price of the stock from $2 to $73, Aron had that deer-in-the-headlights look—he wasn't quite sure what to make of it. As his personal wealth began to grow exponentially thanks to this odd phenomenon, he suddenly got on the bandwagon. Imagine that. Now, he is exhibiting an ape behavior of his very own: his company just took a 22% stake in a floundering, debt-laden gold mining firm. In spite of the obvious connection between a theater chain and a gold mining company, who did the due diligence on this purchase? Shares of the company in question, Hycroft Mining Holding Corp (HYMC), were selling for about $0.30 apiece going into March, which certainly tracks the ape mentality. AMC purchased 23.4 million units, with each unit consisting of one common share of HYMC and one purchase warrant. The units were priced at $1.19 per share, and the warrants are priced around $1.07 and carry a five-year term. Certainly a good deal for Hycroft. If we can say one nice thing about the purchase, it is this: at least the mining company isn't headquartered in the metaverse.
We are ambivalent about virtually every aspect of this story. On the one hand, we want AMC to thrive, as we are not fans of the short sellers, and the Dalian Wanda Group is now out of the picture. On the other hand, the company was never worth anywhere near where the shares were pushed (we still argue they are worth $5 to $10). Likewise, we would like to see Hycroft make it; but Aron is not running a special purpose acquisition company, he is supposed to be running a theater chain. The whole thing seems, as so many analysts have rightly put it, bizarre.
We, 16 Mar 2022
Monetary Policy
Fed's fully-telegraphed move to raise interest rates sent the markets on a crazy afternoon ride
Not only did everyone know an interest rate hike was coming at the Fed's March FOMC meeting, the widely-accepted terminal point—the point at which the hikes would probably cease—was somewhere between 2.5% and 2.75%. That is precisely the script Fed Chair Jerome Powell followed as he announced the 25-basis-point hike and hinted at one more for each of the six remaining meetings for 2022. That would be a total of seven hikes this year, bringing the target band of the Federal funds rate between 1.75% and 2.00%. For no rational reason, the Dow, which had been up as much as 500 points on the day, suddenly went negative. Did the "every meeting will be a live meeting" comment spook the markets? That makes little sense. Powell did seem to calm nerves during his press briefing and Q&A session, and the markets began their second major turnaround of the day. He mentioned the need to begin reducing the Fed's balance sheet beginning "at a coming meeting," which was also expected (The prior $120 billion per month Treasury/MBS buying program finally ended a few weeks ago.) On one hand, we are being told that inflation is out of control due to the Fed's slowness to act; on the other hand, we are being told that too many rate hikes will all but guarantee a recession. Fortunately, Powell and the voting members of the Committee will ignore the chatter and do what they think is right. By the end of the day, the markets applauded the day's events, with the Dow finishing the session up 519 points.
It still amazes us that certain high-ranking individuals (at the time) thought that Powell was too slow to lower rates a few years back, and that rates should essentially stay at zero for the foreseeable future. With the lower band of the FFR at zero, the Fed balance sheet at a stuffed $9 trillion, and inflation at 7.5%, we believe a rate hike at each meeting this year would be a responsible course of action. Now we are being told by a number of high profile economists that a soft landing of the economy will prove to be near impossible, no matter what the Fed does. We don't buy that theory at all, assuming the Ukraine crisis doesn't mushroom into something much larger.
Th, 10 Mar 2022
E-Commerce
Amazon will pursue a 20-for-1 stock split as well as a share buyback program—investors applaud the moves
When I tell people that stock splits are pure financial engineering, and that not one dollar of value is created, I typically hear something like, "But at least the shares will be cheaper for me to buy!" As Charlie Brown says, "Good grief." That being said, I finally heard it put in the perfect way, courtesy of Barron's: "(A stock split) is no different than swapping your $20 bill for 20 singles. Your wallet might be a little fatter, but you aren't any richer." Precisely! Nonetheless, in the case of Amazon (AMZN $2,960), we do support the 20-for-1 stock split they just announced. Why fight the psychology of a $150 share price sounding more appealing to a stock buyer than a $3,000 share price, despite the fact that traders can now buy fractional shares? Another de minimis act was the company's announcement of a $10 billion stock repurchase plan. To you or I, $10B sounds like a lofty sum; to a $1.5 trillion company, it is pocket change. Nonetheless, investors cheered the two moves by pushing Amazon shares up over 6% after the news was released. One tangible benefit the company might receive due to its actions: it is much more likely to be included in the Dow Jones Industrial Average post-split. The DJIA is a price-weighted index, meaning the higher the share price of a member the more its price swings can affect the Dow's swings—not a good thing. Alphabet (GOOG $2,657) announced the exact same stock split plans last month, so the interesting question is which company will get the first invite. Our money is on Google, though we imagine both will eventually earn their way into the rather archaic index.
We said what we thought of Google last month, so what about Amazon shares? They are a bargain, and probably worth in the $4,000 range ($200 post split). Love 'em or hate 'em, this company is only going to get stronger, and the recent tech wreck has the shares trading down about 21% from their recent highs—historically a good sign that it is time to take a position. Amazon is one of the 40 members of the Penn Global Leaders Club.
Trading Desk
Closed out a big pharma company in Global Leaders to make room for a Materials play
We have a strict rule of only carrying 40 great companies in our Penn Global Leaders Club, so when an addition is made, it must take the place of another. In this case, we let our GlaxoSmithKline (GSK $43) go. Actually, to give it more room for potential growth, we closed it from the strategy and simply placed a $40 stop loss on client positions to preserve double-digit gains. To see our undervalued "Materials: Specialty Chemicals" pick up, clients and members can check out the Penn Trading Desk.
Mo, 21 Mar 2022
East & Southeast Asia
Victory for the US and the Western world: South Korea's surprise election results equal a stronger ally in the region
It was a white-knuckler of a race, but when the dust settled South Korea had a new leader. Few expected Yoon Suk-yeol of the Conservative People Power Party to pull off the upset victory, but his win represents the growing angst in South Korea over Kim Jong-un's incessant saber-rattling and China's growing threat to the stability of the region. It also points to the failure of North Korea's decades-long policy of subterfuge; a policy which involves planting false stories and placing North Korean spies in the country to foment a distrust of the government. It has always been Kim Jong-un's (and his father, Kim Jong-il's) master plan to reunite the peninsula not in the name of peace, but in the name of communist rule. Yoon Suk-yeol's victory has splashed cold water on those plans. Not only has this charismatic leader spoken out against the rampant human rights violations in North Korea and China, he has also made it clear that he wants his country to become a "global pivotal state" on the world stage for the cause of freedom. Such language is anathema to Xi Jingping and his dear friend Kim Jong-un. Yoon's victory means he will lead the fourth-largest economy in Asia for at least the next five years. Over that period of time, we can expect much warmer relations between the US and South Korea, a demand that North Korea give up its nuclear ambitions as a basis for negotiations, and an upgrade to the US THAAD anti-missile system in the country—a system which China vehemently opposes. China and North Korea will seek to undermine his rule in every way imaginable, but something tells us this former prosecutor (of nearly three decades) is up for the task.
The pandemic hit South Korea hard, with the country's GDP shrinking by 1% in 2020 before rebounding to 4% in 2021—an eleven-year high. There are three main ETFs to take advantage of South Korea's explosive potential. The Direxion Daily South Korea Bull 3X ETF (KORU $18) we would steer clear of unless conviction is very strong (due to its triple leverage). The Franklin FTSE South Korea ETF (FLKR $25) is run by—in our opinion—the best global investment team in the world (Franklin). and the iShares MSCI South Korea ETF (EWY $71) is the largest, with $4.5 billion AUM. Our personal choice? Go with the Franklin name, FLKR. In addition to Samsung, Kia, Hyundai, and LG, the fund is full of names which few would recognize—hence the importance of the management team.
Fr, 18 Mar 2022
Media & Entertainment
AMC, the movie we can't pull ourselves away from, just took another odd twist: it bought a debt-laden, floundering gold mine
We have always rooted for underdog AMC Entertainment (AMC $16), although our support began to erode when China's Dalian Wanda Group became controlling owner, and further when CEO Adam Aron remained in his hometown of Philly to run the Leawood, Kansas-based theater chain. We can almost picture the images that popped into the head of the Harvard grad when he found out where it was headquartered. Probably cornfields and rolling tumbleweeds. But, as the likes of Radio Shack, Toys R Us, and Borders (books) began succumbing to the march of time, we really wanted AMC to survive. Of course, we all know what happened next. When the AMC apes first began moving the share price of the stock from $2 to $73, Aron had that deer-in-the-headlights look—he wasn't quite sure what to make of it. As his personal wealth began to grow exponentially thanks to this odd phenomenon, he suddenly got on the bandwagon. Imagine that. Now, he is exhibiting an ape behavior of his very own: his company just took a 22% stake in a floundering, debt-laden gold mining firm. In spite of the obvious connection between a theater chain and a gold mining company, who did the due diligence on this purchase? Shares of the company in question, Hycroft Mining Holding Corp (HYMC), were selling for about $0.30 apiece going into March, which certainly tracks the ape mentality. AMC purchased 23.4 million units, with each unit consisting of one common share of HYMC and one purchase warrant. The units were priced at $1.19 per share, and the warrants are priced around $1.07 and carry a five-year term. Certainly a good deal for Hycroft. If we can say one nice thing about the purchase, it is this: at least the mining company isn't headquartered in the metaverse.
We are ambivalent about virtually every aspect of this story. On the one hand, we want AMC to thrive, as we are not fans of the short sellers, and the Dalian Wanda Group is now out of the picture. On the other hand, the company was never worth anywhere near where the shares were pushed (we still argue they are worth $5 to $10). Likewise, we would like to see Hycroft make it; but Aron is not running a special purpose acquisition company, he is supposed to be running a theater chain. The whole thing seems, as so many analysts have rightly put it, bizarre.
We, 16 Mar 2022
Monetary Policy
Fed's fully-telegraphed move to raise interest rates sent the markets on a crazy afternoon ride
Not only did everyone know an interest rate hike was coming at the Fed's March FOMC meeting, the widely-accepted terminal point—the point at which the hikes would probably cease—was somewhere between 2.5% and 2.75%. That is precisely the script Fed Chair Jerome Powell followed as he announced the 25-basis-point hike and hinted at one more for each of the six remaining meetings for 2022. That would be a total of seven hikes this year, bringing the target band of the Federal funds rate between 1.75% and 2.00%. For no rational reason, the Dow, which had been up as much as 500 points on the day, suddenly went negative. Did the "every meeting will be a live meeting" comment spook the markets? That makes little sense. Powell did seem to calm nerves during his press briefing and Q&A session, and the markets began their second major turnaround of the day. He mentioned the need to begin reducing the Fed's balance sheet beginning "at a coming meeting," which was also expected (The prior $120 billion per month Treasury/MBS buying program finally ended a few weeks ago.) On one hand, we are being told that inflation is out of control due to the Fed's slowness to act; on the other hand, we are being told that too many rate hikes will all but guarantee a recession. Fortunately, Powell and the voting members of the Committee will ignore the chatter and do what they think is right. By the end of the day, the markets applauded the day's events, with the Dow finishing the session up 519 points.
It still amazes us that certain high-ranking individuals (at the time) thought that Powell was too slow to lower rates a few years back, and that rates should essentially stay at zero for the foreseeable future. With the lower band of the FFR at zero, the Fed balance sheet at a stuffed $9 trillion, and inflation at 7.5%, we believe a rate hike at each meeting this year would be a responsible course of action. Now we are being told by a number of high profile economists that a soft landing of the economy will prove to be near impossible, no matter what the Fed does. We don't buy that theory at all, assuming the Ukraine crisis doesn't mushroom into something much larger.
Th, 10 Mar 2022
E-Commerce
Amazon will pursue a 20-for-1 stock split as well as a share buyback program—investors applaud the moves
When I tell people that stock splits are pure financial engineering, and that not one dollar of value is created, I typically hear something like, "But at least the shares will be cheaper for me to buy!" As Charlie Brown says, "Good grief." That being said, I finally heard it put in the perfect way, courtesy of Barron's: "(A stock split) is no different than swapping your $20 bill for 20 singles. Your wallet might be a little fatter, but you aren't any richer." Precisely! Nonetheless, in the case of Amazon (AMZN $2,960), we do support the 20-for-1 stock split they just announced. Why fight the psychology of a $150 share price sounding more appealing to a stock buyer than a $3,000 share price, despite the fact that traders can now buy fractional shares? Another de minimis act was the company's announcement of a $10 billion stock repurchase plan. To you or I, $10B sounds like a lofty sum; to a $1.5 trillion company, it is pocket change. Nonetheless, investors cheered the two moves by pushing Amazon shares up over 6% after the news was released. One tangible benefit the company might receive due to its actions: it is much more likely to be included in the Dow Jones Industrial Average post-split. The DJIA is a price-weighted index, meaning the higher the share price of a member the more its price swings can affect the Dow's swings—not a good thing. Alphabet (GOOG $2,657) announced the exact same stock split plans last month, so the interesting question is which company will get the first invite. Our money is on Google, though we imagine both will eventually earn their way into the rather archaic index.
We said what we thought of Google last month, so what about Amazon shares? They are a bargain, and probably worth in the $4,000 range ($200 post split). Love 'em or hate 'em, this company is only going to get stronger, and the recent tech wreck has the shares trading down about 21% from their recent highs—historically a good sign that it is time to take a position. Amazon is one of the 40 members of the Penn Global Leaders Club.
We, 09 Mar 2022
Global Strategy: Latin America
Strange bedfellows: Invasion of Ukraine has opened up a doorway to Venezuela, with Maduro talking capitalism
"Misery acquaints a man with strange bedfellows," as Shakespeare posited in his play, The Tempest, and what is going on between the United States and Venezuela right now underscores that point. President Nicolas Maduro, whose leadership seemed to be hanging from a thread as hyperinflation inundated his country, has to be looking on in satisfaction as Putin's invasion of Ukraine has diverted the world's attention. Now, it appears that the Russian energy embargo in the US has opened up an opportunity for trade to resume between the two nations. Officials from the Biden administration headed into a secret meeting last weekend in Caracas; when it was over, Maduro had agreed to release two political prisoners from the United States in return for discussions over lifting some trade sanctions. Holding some 17.8% of the world's proven oil reserves, and with the Keystone pipeline from Canada having been killed by the administration, the truth is we could sorely use oil from our erstwhile political opponent in South America. For his part, Maduro seems to be almost embracing capitalism in an effort to staunch the mass exodus of citizens and bring a halt to hyperinflation. Most socialists tend to double down on the failed philosophy of Marx when backed into a corner, so this is a hopeful sign.
In its heyday, Venezuela produced around 3 million barrels of oil per day; thanks to sanctions and infrastructure issues, that figure is now down to around 800,000. By comparison, the US produces nearly 12 million barrels of oil per day—more than Russia and more than Saudi Arabia. With its vast store of reserves and some technical support, Venezuela could (relatively) quickly double its output. If Maduro is truly interested in bringing his country back from the brink, he must make a host of pro-free-market moves for this to happen. He just made one: he will allow US dollars to flow freely throughout the country once again, meaning workers can be paid with the greenback instead of the virtually worthless bolivar, and companies will be allowed to issue debt in foreign currencies. In another hopeful sign, a recent poll showed only 38% of Venezuelans wish to flee their country. In a sad commentary, that is a dramatic improvement from a similar poll taken a few years ago. The ball is in Maduro's court.
We are not under any false impression that Venezuela is suddenly going to become a Chile, Colombia, or even Mexico with respect to the country's relationship with the US, but even a small thawing of relations should equate to the open flow of oil once again. And that is something which would benefit both economies—and certainly buttress Maduro's grip on power.
Global Strategy: Latin America
Strange bedfellows: Invasion of Ukraine has opened up a doorway to Venezuela, with Maduro talking capitalism
"Misery acquaints a man with strange bedfellows," as Shakespeare posited in his play, The Tempest, and what is going on between the United States and Venezuela right now underscores that point. President Nicolas Maduro, whose leadership seemed to be hanging from a thread as hyperinflation inundated his country, has to be looking on in satisfaction as Putin's invasion of Ukraine has diverted the world's attention. Now, it appears that the Russian energy embargo in the US has opened up an opportunity for trade to resume between the two nations. Officials from the Biden administration headed into a secret meeting last weekend in Caracas; when it was over, Maduro had agreed to release two political prisoners from the United States in return for discussions over lifting some trade sanctions. Holding some 17.8% of the world's proven oil reserves, and with the Keystone pipeline from Canada having been killed by the administration, the truth is we could sorely use oil from our erstwhile political opponent in South America. For his part, Maduro seems to be almost embracing capitalism in an effort to staunch the mass exodus of citizens and bring a halt to hyperinflation. Most socialists tend to double down on the failed philosophy of Marx when backed into a corner, so this is a hopeful sign.
In its heyday, Venezuela produced around 3 million barrels of oil per day; thanks to sanctions and infrastructure issues, that figure is now down to around 800,000. By comparison, the US produces nearly 12 million barrels of oil per day—more than Russia and more than Saudi Arabia. With its vast store of reserves and some technical support, Venezuela could (relatively) quickly double its output. If Maduro is truly interested in bringing his country back from the brink, he must make a host of pro-free-market moves for this to happen. He just made one: he will allow US dollars to flow freely throughout the country once again, meaning workers can be paid with the greenback instead of the virtually worthless bolivar, and companies will be allowed to issue debt in foreign currencies. In another hopeful sign, a recent poll showed only 38% of Venezuelans wish to flee their country. In a sad commentary, that is a dramatic improvement from a similar poll taken a few years ago. The ball is in Maduro's court.
We are not under any false impression that Venezuela is suddenly going to become a Chile, Colombia, or even Mexico with respect to the country's relationship with the US, but even a small thawing of relations should equate to the open flow of oil once again. And that is something which would benefit both economies—and certainly buttress Maduro's grip on power.
On the bright side, Venezuela's inflation rate is back down below 2,000%; Weimar Republic, anyone?
Tu, 08 Mar 2022
Global Strategy: Eastern Europe
As tech companies from around the world end shipments to Russia, Chinese firms are licking their chops
Last week, Apple (AAPL $159) stopped selling its products in Russia and removed state-controlled RT News from its App Store. Although the company doesn't have a physical footprint in Russia, visitors to the online Apple store would get the message that products are "unavailable for purchase or delivery." No problem, right? Russians can simply turn to the Samsung Galaxy. Not so fast. South Korea's Samsung, which holds a larger market share than Apple in the country, just announced that it, too, would halt all shipments of phones to Russia, in addition to consumer electronics and chips. On the tech front, similar moves have been made by the likes of Microsoft, Electronic Arts, Nintendo, IBM, Intel, and Sony. The united global front against Russia's invasion of Ukraine has been nothing short of remarkable. Sadly, this united front does not extend to that country's neighbor to the south: China. China-based Xiaomi is the second-largest phone seller in Russia, while Hong Kong-based Lenovo holds that distinction in the PC market (behind HP, which is also halting sales). Huawei Technologies, based out of Shenzhen, China, is already Russia's top telecom equipment provider, and the company has been battling Sweden's Ericsson for 5G contracts in the country. The latter announced back on 28 Feb that it would suspend deliveries until Russia ends its war against Ukraine. There is no doubt a stronger economic and even military alliance forming between Communist China and the former communist state of Russia—birds of a feather, but the worldwide condemnation of Russia's military actions will make the new love affair tenuous for Xi Jinping and the ruling CCP. Especially in the year when Xi hopes to cement his role as "ruler for life." And that last factor is really all we need to know about China and Russia to understand the nature of the threat the West faces going forward.
Despite their love affair, both Xi and Putin have undoubtedly been shocked by the level of global cohesiveness against Russian aggression. China has so much as telegraphed that this is all about Taiwan, a nation which will one day face the same fate as Ukraine. The greatest weapon the West has against these leaders is their own hubris. "Leader for life" may look great on paper, but maintaining order and controlling the narrative in this new world of smartphones, communication satellites, and Internet access will be a Herculean task—especially as the civilized world continues to wake up to the threat both pose on the world scene. Two years and two disasters later, no sane mind could argue that those threats aren't clear and present.
Global Strategy: Eastern Europe
As tech companies from around the world end shipments to Russia, Chinese firms are licking their chops
Last week, Apple (AAPL $159) stopped selling its products in Russia and removed state-controlled RT News from its App Store. Although the company doesn't have a physical footprint in Russia, visitors to the online Apple store would get the message that products are "unavailable for purchase or delivery." No problem, right? Russians can simply turn to the Samsung Galaxy. Not so fast. South Korea's Samsung, which holds a larger market share than Apple in the country, just announced that it, too, would halt all shipments of phones to Russia, in addition to consumer electronics and chips. On the tech front, similar moves have been made by the likes of Microsoft, Electronic Arts, Nintendo, IBM, Intel, and Sony. The united global front against Russia's invasion of Ukraine has been nothing short of remarkable. Sadly, this united front does not extend to that country's neighbor to the south: China. China-based Xiaomi is the second-largest phone seller in Russia, while Hong Kong-based Lenovo holds that distinction in the PC market (behind HP, which is also halting sales). Huawei Technologies, based out of Shenzhen, China, is already Russia's top telecom equipment provider, and the company has been battling Sweden's Ericsson for 5G contracts in the country. The latter announced back on 28 Feb that it would suspend deliveries until Russia ends its war against Ukraine. There is no doubt a stronger economic and even military alliance forming between Communist China and the former communist state of Russia—birds of a feather, but the worldwide condemnation of Russia's military actions will make the new love affair tenuous for Xi Jinping and the ruling CCP. Especially in the year when Xi hopes to cement his role as "ruler for life." And that last factor is really all we need to know about China and Russia to understand the nature of the threat the West faces going forward.
Despite their love affair, both Xi and Putin have undoubtedly been shocked by the level of global cohesiveness against Russian aggression. China has so much as telegraphed that this is all about Taiwan, a nation which will one day face the same fate as Ukraine. The greatest weapon the West has against these leaders is their own hubris. "Leader for life" may look great on paper, but maintaining order and controlling the narrative in this new world of smartphones, communication satellites, and Internet access will be a Herculean task—especially as the civilized world continues to wake up to the threat both pose on the world scene. Two years and two disasters later, no sane mind could argue that those threats aren't clear and present.
Mo, 07 Mar 2022
Trading Desk
Adding two Application & Systems Software companies to the Intrepid Trading Platform
Two companies which helped transform their respective industries during the pandemic; two companies which will continue to dominate their respective space and gain market share; two companies whose shares are off roughly 75% from their 2021 highs. We added both to the Intrepid Trading Platform in the midst of the current tech wreck. Great companies are being pilloried, making for great bargains in the market. Members can see the trade by logging into the Trading Desk.
Fr, 04 Mar 2022
Work & Pay
Huge jobs number: 678,000 new positions created in February
The US added a whopping 678,000 new payrolls in the month of February, with the unemployment rate dropping down from 4% to 3.8%. Wall Street had been expecting those figures to come in at 440,000 and 3.9%, respectively. This amounts to the best jobs report since last July, before the Omicron variant of the virus hit US shores. Indications that inflation could be starting to cool a bit came from the wage figures in the report: hourly wages grew just $0.01 per hour, or roughly half of what was expected. Year-over-year wage growth is now 5.13%, also below expectations. In a sign that the economy is back on its reopening path, the leisure and hospitality industries led the gains, with 179,000 new jobs created, with the unemployment rate in those two areas dropping from 8.2% to 6.6%. Other areas showing strong gains for the month include professional and business services, health care, construction, and transportation.
Not that anyone is expecting the Fed to hold off on rate hikes starting this month, but this report certainly adds fuel to the fire for a normalization of rates, with the terminal number floating somewhere around 2.5% (the lower band sits at 0% right now). Unfortunately, the strong jobs numbers were overshadowed by Russia's attack on the nuclear facility in Ukraine. That story continues to be at center stage.
Trading Desk
Adding two Application & Systems Software companies to the Intrepid Trading Platform
Two companies which helped transform their respective industries during the pandemic; two companies which will continue to dominate their respective space and gain market share; two companies whose shares are off roughly 75% from their 2021 highs. We added both to the Intrepid Trading Platform in the midst of the current tech wreck. Great companies are being pilloried, making for great bargains in the market. Members can see the trade by logging into the Trading Desk.
Fr, 04 Mar 2022
Work & Pay
Huge jobs number: 678,000 new positions created in February
The US added a whopping 678,000 new payrolls in the month of February, with the unemployment rate dropping down from 4% to 3.8%. Wall Street had been expecting those figures to come in at 440,000 and 3.9%, respectively. This amounts to the best jobs report since last July, before the Omicron variant of the virus hit US shores. Indications that inflation could be starting to cool a bit came from the wage figures in the report: hourly wages grew just $0.01 per hour, or roughly half of what was expected. Year-over-year wage growth is now 5.13%, also below expectations. In a sign that the economy is back on its reopening path, the leisure and hospitality industries led the gains, with 179,000 new jobs created, with the unemployment rate in those two areas dropping from 8.2% to 6.6%. Other areas showing strong gains for the month include professional and business services, health care, construction, and transportation.
Not that anyone is expecting the Fed to hold off on rate hikes starting this month, but this report certainly adds fuel to the fire for a normalization of rates, with the terminal number floating somewhere around 2.5% (the lower band sits at 0% right now). Unfortunately, the strong jobs numbers were overshadowed by Russia's attack on the nuclear facility in Ukraine. That story continues to be at center stage.
Headlines for the Week of 20 Feb 2022 — 26 Feb 2022
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Swap Aerospace & Defense funds within Dynamic Growth Strategy
We are overweighting Industrials in 2022, especially within the Aerospace & Defense industries. Within our ETF-based Penn Dynamic Growth Strategy we are replacing our long-term iShares US Aerospace & Defense ETF (ITA $108) holding with another specialty player in the category. ITA has remained faithful to Boeing (BA $201) for far too long, and the company's 17.5% representation in the fund is unacceptable. The top two holdings in the fund—one of which is Boeing—account for a 40% weighting. We have replaced ITA with a more well-balanced fund comprised of 52 strong holdings in the aerospace and defense arenas.
Penn: Open agriculture play in Dynamic Growth Strategy
A confluence of events has created a very favorable environment for commodities, particularly agriculture products. Within the Penn Dynamics Growth Strategy, we have replaced our 4% position in ROBO—a robotics and automation ETF—with a well-managed commodities vehicle focused on agriculture. Investors are seeking instruments with a low to inverse correlation to stocks and bonds right now, and commodities have historically filled the bill.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Market Pulse
Invasion Day: What we can learn from the Dow's near-1,000 point swing last Thursday
Considering the headline, "Russia invades Ukraine," last Thursday's early session bloodbath certainly seemed to make sense. The Dow was in the red by 859 points in short order, causing us to have flashbacks to the multiple 2,000-point-drop days in March of 2020, almost two years ago to the month. All of the major indexes were off by 2.5% or more. Then, something remarkable happened: the markets staged their great comeback. Led by the NASDAQ, then followed by the S&P 500 and—grudgingly—the Dow, all of the indexes ended the day in the green. For the Dow, that represented a 963-point swing from bottom to close. The S&P 500 ended the day up 1.56% while the NASDAQ was in the green by 3.34%, with many recent "opening trade punching bags" moving higher by double digits.
The knee-jerk reaction coming from analysts was that the market liked President Biden's new round of measured sanctions—just enough to potentially make Putin think twice about his course of action, but not so draconian as to hurt Western allies (like limiting the flow of Russian gas and oil, or cutting Russia out of the Swift global payment system). But the rebound, we believe, goes a bit deeper than that. In the first place, it all but assured a more measured pace of Fed rate hikes and balance sheet reduction, as opposed to the 50-basis-point March hike and seven rate hikes that the likes of Bank of America had been calling for (we never believed that would happen). Additionally, we felt a real sense that many investors who had been waiting for the bottoming of the recent market trough decided that this was the moment to get back in. That notion was buttressed by Friday's 835-point Dow follow through. Time will tell whether or not this represented a turnaround from the brutal past few months, but the rapid shift in market sentiment was heartening. CNBC's Bob Pisani perhaps put it best when he said, "I've been on the (trading) floor for twenty-five years; you don't see many weeks like this."
If we are on the happy side of a bottoming out, here is a tempting morsel for would-be buyers: 51% of S&P 500 stocks and 76% of NASDAQ stocks are still in bear market territory. Many quality NASDAQ names (strong revenues, needed products and services) remain 50% or more below their 52-week highs.
Textiles, Apparel, & Luxury Goods
Foot Locker gaps down by a third as management gives sobering guidance, outlines Nike problems
Shares of retailer Foot Locker (FL $29) plunged over 30% last Friday after management said it expects weaker sales and earnings this year due to supply chain issues and economic factors such as raging inflation. Furthermore, the company admitted that Nike's (NKE $137) decision to focus on direct-to-consumer sales at the expense of its third-party sellers (such as Foot Locker) will have a deleterious effect on the company, at least in the short term. To put that statement in perspective, nearly 70% of Foot Locker sales in 2021 were of Nike products. How much of a hit does management expect to take in 2022? The company is projecting a sales decline of between 8% and 10% this year. As for the quarterly earnings, the numbers were a mixed bag: Sales grew from $2.19 billion in the same quarter of the previous year to $2.34 billion this past quarter; however, thanks to higher supply-chain costs, net income for the quarter fell 16% from the previous year, to $103 million. Foot locker has nearly 3,000 retail stores around the world, with management expecting to trim that figure by roughly 3% this year.
We could easily make a convincing argument for a $50 fair value on FL shares, which would equate to a 67% gain in the share price. The company's financial health is strong, it has a tiny P/E ratio of 3.4, and a price-to-sales ratio of 0.36. A $3 billion small cap in the specialty retail space is not for the faint of heart at this moment in time, but it has a nice risk/reward profile for more "aggressive money." We would recommend a stop loss around $27.60 on any purchase of the shares.
Europe
Trump couldn't get Germany to raise its defense spending; Putin just did
Just how mentally stable Vladimir Putin is right now is open for debate, but one component of his unprovoked invasion of neighboring Ukraine is crystal clear: he is taken aback by the cohesion of the Western world against his actions; specifically, Germany. Germany has become irresponsibly reliant on Russia, a condition going back at least as far as Angela Merkel's ascension to power in 2005. This has always seemed strange to us, as she was raised in East Germany under the thumb of the Soviet empire. She is also highly intelligent, earning her doctorate in quantum chemistry and working as a research scientist before the fall of the Berlin Wall. It is hard to imagine anyone more acutely aware of Russia's tactics than Merkel. Nonetheless, as the country phased out coal and nuclear energy, Germany's leadership allowed itself to become more and more reliant on Russian commodities, especially in the energy sector.
Chancellor Merkel's party recently suffered its worst defeat since it was founded in the aftermath of World War II in 1945. The country's new leader is Olaf Scholz, head of the center-left Social Democratic Party (SPD). His party, and the Greens who have formed an alliance with the SPD, have never been fond of the already-built Nord Stream 2 pipeline, but Putin was angered (and surprised, we would argue) when Germany actually halted approval of the pipeline for operational status due to the invasion. Now, they are taking steps which have surprised even us: they are planning on a massive boost in defense spending.
That is something Germany is not known for doing, to put it mildly. Just ask former President Donald Trump, who vociferously and unsuccessfully argued that our European allies needed to at least hit NATO's 2% of GDP target for defense spending. Now, thanks to Putin's aggression on the continent, Scholz has announced that his government will funnel 100 billion euros ($113B USD) into a modernization fund for Germany's military. Additionally, he announced that the country would allot at least the 2% target on defense spending by 2024. On a related note, Germany even said it would supply weapons to Ukrainian fighters—a dramatic change in posture for the nation, and certainly the SPD, which has a history of warm ties to Moscow.
Germany's moves are great news for the cause of freedom. The wild card, however, remains Putin's state of mind. It is rather disturbing to consider just how far this mercurial autocrat will go to prevent his image from being damaged or ego from being bruised. Sadly, we cannot rely on the Chinese government to coerce its ally into pulling back. Winnie the Pooh's evil doppelganger is trying to portray an image of China being above the fray, but it is evident which side his country supports. Birds of a feather....
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Swap Aerospace & Defense funds within Dynamic Growth Strategy
We are overweighting Industrials in 2022, especially within the Aerospace & Defense industries. Within our ETF-based Penn Dynamic Growth Strategy we are replacing our long-term iShares US Aerospace & Defense ETF (ITA $108) holding with another specialty player in the category. ITA has remained faithful to Boeing (BA $201) for far too long, and the company's 17.5% representation in the fund is unacceptable. The top two holdings in the fund—one of which is Boeing—account for a 40% weighting. We have replaced ITA with a more well-balanced fund comprised of 52 strong holdings in the aerospace and defense arenas.
Penn: Open agriculture play in Dynamic Growth Strategy
A confluence of events has created a very favorable environment for commodities, particularly agriculture products. Within the Penn Dynamics Growth Strategy, we have replaced our 4% position in ROBO—a robotics and automation ETF—with a well-managed commodities vehicle focused on agriculture. Investors are seeking instruments with a low to inverse correlation to stocks and bonds right now, and commodities have historically filled the bill.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Market Pulse
Invasion Day: What we can learn from the Dow's near-1,000 point swing last Thursday
Considering the headline, "Russia invades Ukraine," last Thursday's early session bloodbath certainly seemed to make sense. The Dow was in the red by 859 points in short order, causing us to have flashbacks to the multiple 2,000-point-drop days in March of 2020, almost two years ago to the month. All of the major indexes were off by 2.5% or more. Then, something remarkable happened: the markets staged their great comeback. Led by the NASDAQ, then followed by the S&P 500 and—grudgingly—the Dow, all of the indexes ended the day in the green. For the Dow, that represented a 963-point swing from bottom to close. The S&P 500 ended the day up 1.56% while the NASDAQ was in the green by 3.34%, with many recent "opening trade punching bags" moving higher by double digits.
The knee-jerk reaction coming from analysts was that the market liked President Biden's new round of measured sanctions—just enough to potentially make Putin think twice about his course of action, but not so draconian as to hurt Western allies (like limiting the flow of Russian gas and oil, or cutting Russia out of the Swift global payment system). But the rebound, we believe, goes a bit deeper than that. In the first place, it all but assured a more measured pace of Fed rate hikes and balance sheet reduction, as opposed to the 50-basis-point March hike and seven rate hikes that the likes of Bank of America had been calling for (we never believed that would happen). Additionally, we felt a real sense that many investors who had been waiting for the bottoming of the recent market trough decided that this was the moment to get back in. That notion was buttressed by Friday's 835-point Dow follow through. Time will tell whether or not this represented a turnaround from the brutal past few months, but the rapid shift in market sentiment was heartening. CNBC's Bob Pisani perhaps put it best when he said, "I've been on the (trading) floor for twenty-five years; you don't see many weeks like this."
If we are on the happy side of a bottoming out, here is a tempting morsel for would-be buyers: 51% of S&P 500 stocks and 76% of NASDAQ stocks are still in bear market territory. Many quality NASDAQ names (strong revenues, needed products and services) remain 50% or more below their 52-week highs.
Textiles, Apparel, & Luxury Goods
Foot Locker gaps down by a third as management gives sobering guidance, outlines Nike problems
Shares of retailer Foot Locker (FL $29) plunged over 30% last Friday after management said it expects weaker sales and earnings this year due to supply chain issues and economic factors such as raging inflation. Furthermore, the company admitted that Nike's (NKE $137) decision to focus on direct-to-consumer sales at the expense of its third-party sellers (such as Foot Locker) will have a deleterious effect on the company, at least in the short term. To put that statement in perspective, nearly 70% of Foot Locker sales in 2021 were of Nike products. How much of a hit does management expect to take in 2022? The company is projecting a sales decline of between 8% and 10% this year. As for the quarterly earnings, the numbers were a mixed bag: Sales grew from $2.19 billion in the same quarter of the previous year to $2.34 billion this past quarter; however, thanks to higher supply-chain costs, net income for the quarter fell 16% from the previous year, to $103 million. Foot locker has nearly 3,000 retail stores around the world, with management expecting to trim that figure by roughly 3% this year.
We could easily make a convincing argument for a $50 fair value on FL shares, which would equate to a 67% gain in the share price. The company's financial health is strong, it has a tiny P/E ratio of 3.4, and a price-to-sales ratio of 0.36. A $3 billion small cap in the specialty retail space is not for the faint of heart at this moment in time, but it has a nice risk/reward profile for more "aggressive money." We would recommend a stop loss around $27.60 on any purchase of the shares.
Europe
Trump couldn't get Germany to raise its defense spending; Putin just did
Just how mentally stable Vladimir Putin is right now is open for debate, but one component of his unprovoked invasion of neighboring Ukraine is crystal clear: he is taken aback by the cohesion of the Western world against his actions; specifically, Germany. Germany has become irresponsibly reliant on Russia, a condition going back at least as far as Angela Merkel's ascension to power in 2005. This has always seemed strange to us, as she was raised in East Germany under the thumb of the Soviet empire. She is also highly intelligent, earning her doctorate in quantum chemistry and working as a research scientist before the fall of the Berlin Wall. It is hard to imagine anyone more acutely aware of Russia's tactics than Merkel. Nonetheless, as the country phased out coal and nuclear energy, Germany's leadership allowed itself to become more and more reliant on Russian commodities, especially in the energy sector.
Chancellor Merkel's party recently suffered its worst defeat since it was founded in the aftermath of World War II in 1945. The country's new leader is Olaf Scholz, head of the center-left Social Democratic Party (SPD). His party, and the Greens who have formed an alliance with the SPD, have never been fond of the already-built Nord Stream 2 pipeline, but Putin was angered (and surprised, we would argue) when Germany actually halted approval of the pipeline for operational status due to the invasion. Now, they are taking steps which have surprised even us: they are planning on a massive boost in defense spending.
That is something Germany is not known for doing, to put it mildly. Just ask former President Donald Trump, who vociferously and unsuccessfully argued that our European allies needed to at least hit NATO's 2% of GDP target for defense spending. Now, thanks to Putin's aggression on the continent, Scholz has announced that his government will funnel 100 billion euros ($113B USD) into a modernization fund for Germany's military. Additionally, he announced that the country would allot at least the 2% target on defense spending by 2024. On a related note, Germany even said it would supply weapons to Ukrainian fighters—a dramatic change in posture for the nation, and certainly the SPD, which has a history of warm ties to Moscow.
Germany's moves are great news for the cause of freedom. The wild card, however, remains Putin's state of mind. It is rather disturbing to consider just how far this mercurial autocrat will go to prevent his image from being damaged or ego from being bruised. Sadly, we cannot rely on the Chinese government to coerce its ally into pulling back. Winnie the Pooh's evil doppelganger is trying to portray an image of China being above the fray, but it is evident which side his country supports. Birds of a feather....
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
- George Washington was chosen as he was the Founding Father of the nation
- Thomas Jefferson was chosen to represent expansion, as the author of the Declaration of Independence and the promoter/signer of the Louisiana Purchase (which doubled the size of the US)
- Theodore Roosevelt was chosen because he represented conservation (he established 150 national forests, 50 federal bird reserves, 4 national game preserves, 5 national parks, and 18 national monuments on over 230 million acres of newly-protected land)
- Abraham Lincoln was chosen for leading the United States through the bloody Civil War and his belief that the nation "must be preserved at any cost."
Headlines for the Week of 13 Feb 2022 — 19 Feb 2022
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Open immersive gaming platform in New Frontier Fund
We have been waiting for a catalyst to bring shares of this forward-looking media and entertainment company down within our price range; we got it in the form of Market reaction to an earnings report. Added to the Penn New Frontier Fund with an initial price target 79% higher than our purchase price, though we have no plans to sell it when that first target is hit.
Penn: Open Application Software company in the New Frontier Fund
When you see the name, you may scratch your head as to why it is listed as an Application & Systems Software company, but it is. We added this industry leader to the New Frontier Fund with a target price 101% above our purchase price. We believe the market has grossly misjudged this company.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Airlines
Merger of the low-cost carriers: Frontier to buy Spirit Airlines in $6.6 billion deal
Denver-based Frontier (ULCC $12) is a $2.6 billion ultra-low-cost carrier serving 90 destinations with a fleet of 60 single-aisle Airbus aircraft. Florida-based Spirit Airlines (SAVE $24) is a $2.3 billion ultra-low-cost carrier serving 78 destinations with a fleet of 157 single-aisle Airbus aircraft. Both small cap airlines have lost money since the pandemic. With so much in common, it makes sense that these two airlines, both focused on leisure travel, would join forces. Our only question is the price-tag: Frontier has agreed to buy Spirit in a deal valued at $6.6 billion—or around $1.7 billion more than the combined companies' market cap at the end of last week. If the merger is approved (it should be, but with the current DoJ, who knows), it would create the country's fifth-largest airline, behind American, Delta, Southwest, and United. We know that Frontier would control 51.5% of the merged company, with Spirit shareholders owning the other 48.5%. What has yet to be determined is who will be the CEO, what the entity will be called, and where it will be headquartered. Bill Franke, the current chair of Frontier and managing partner of parent company Indigo Parters, will remain in his role, however. Although its IPO was delayed due to the pandemic, Frontier finally went public on the NASDAQ last April, opening around $19 per share.
We like this deal a lot. In fact, it is fair to say that it needed to be done for the long-term viability of both companies. Both carriers have aggressive growth plans, and the combined entity should begin operations before the end of this year, just as leisure travel begins to take off once again. We wouldn't touch shares of either company, however, before the DoT/DoJ appear ready to give the green light to the merger. We own United Airlines Holdings (UAL $44) in the Penn Global Leaders Club.
Bear Market Chatter
The economy—and the markets—should be able to withstand the coming tightening cycle
Want an idea of how the markets might react to a multi-year series of rate hikes? Look no further than 2015 through 2018. In the three-year period between December of 2015 and December of 2018, the Fed initiated a total of nine, 25-basis-point hikes, taking the lower band of the Fed funds rate from 0% to 2.25%. That same scenario seems completely plausible this time around. Common sense test: It is rather difficult to imagine would-be home buyers proclaiming, "A 6% mortgage rate? That's it, we're out!" (6% is probably the max rates would spike to; they peaked at 4.94% during the last tightening cycle.)
Just as the last series of hikes didn't chase away buyers, it also didn't run off investors. Sure, we had that ugly fourth-quarter downturn in 2018 which culminated in a negative year, but that was the result of trade tensions, D.C.'s battle with big tech, and a host of other concerning headlines. By April of 2019, the Q4 losses had been erased, and the markets were off to the races once again—at least until a global pandemic entered the field.
Yes, piloting a so-called "soft landing" of the economy is going to require some finesse by the Fed, but we don't buy the current narrative that inflation is so out of control that it cannot be subdued. Supply chain issues will abate this year, higher rates will help dampen the unbridled enthusiasm which has pushed up the cost of new and used vehicles and homes, and technology will continue to put downward pressure on prices. Add needed tightening to the mix and we can make a good argument for a decent year ahead, especially after the market's recent pullback. We retain our 5,100 target price for the S&P 500 (which is suddenly sounding a lot better), with the caveat that we are due a negative year—much like the one we had in 2018.
Quantitative tightening will probably continue into 2023 and then end at some point in the year. The Fed should be able to whittle its balance sheet down to a more manageable (yet still unacceptable) $7 trillion or so. We do see a recession on the horizon, but that will most likely come to pass in the second half of 2023 or in the election year of 2024.
Monetary Policy
The Bank of America analyst who predicted seven rate hikes this year isn't too concerned about the tightening yield curve
We just explained why investors shouldn't be overly concerned with a series of rate hikes, but what about concern over the flattening yield curve? Many economists are wringing their hands over the tightening spread between the 2-year Treasury and the 10-year Treasury, with some seemingly wired to believe that an inverted curve (the blue line on the chart going below 0.00%) signals a recession is all but guaranteed. Ironically, we turn to someone whose rate hike predictions we don't buy to explain why this is not necessarily the case. There's an old joke—at the expense of economists—which says, "The yield curve has predicted eight out of the last four recessions." Funny. Bank of America's head of global economics, who is calling for seven hikes in 2022 and another four in 2023, made an interesting observation about the tightening curve. He argues that foreign investors are flooding in to buy 10-year US Treasuries because they are faced with zero—or even negative—rates back home. That is a great point. As demand goes up for the longer notes, the law of supply and demand says prices will naturally go up. In Bond World, high demand and higher prices means yields will naturally fall. Picture the teeter-totter rule of bonds. The longer the maturity, the further out on the teeter-totter the bonds sit. On the opposite side of price for any given maturity sits yield. In other words, as prices go up, yields come down, and the longer the duration or maturity, the faster this takes place. Yes, the Fed will raise rates, but they can only affect the short end, sitting nearest the fulcrum on our imaginary piece of playground equipment. This is certainly one strong explanation for the tightening curve. For the record, the B of A analyst, Ethan Harris, also believes that inflation will come down naturally to the 3% range or so in the not-too-distant future as a result of supply constraints easing and the economy getting back to more normal levels. So, we agree with everything he is espousing except for the eleven rate hikes.
We are sticking with our prediction of four, 25-basis-point hikes this year, and four more in 2023; this would place the Fed funds rate at a quite accommodative 2%. If that rate freaks the market out, we have bigger concerns about the psyche of investors.
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Open immersive gaming platform in New Frontier Fund
We have been waiting for a catalyst to bring shares of this forward-looking media and entertainment company down within our price range; we got it in the form of Market reaction to an earnings report. Added to the Penn New Frontier Fund with an initial price target 79% higher than our purchase price, though we have no plans to sell it when that first target is hit.
Penn: Open Application Software company in the New Frontier Fund
When you see the name, you may scratch your head as to why it is listed as an Application & Systems Software company, but it is. We added this industry leader to the New Frontier Fund with a target price 101% above our purchase price. We believe the market has grossly misjudged this company.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Airlines
Merger of the low-cost carriers: Frontier to buy Spirit Airlines in $6.6 billion deal
Denver-based Frontier (ULCC $12) is a $2.6 billion ultra-low-cost carrier serving 90 destinations with a fleet of 60 single-aisle Airbus aircraft. Florida-based Spirit Airlines (SAVE $24) is a $2.3 billion ultra-low-cost carrier serving 78 destinations with a fleet of 157 single-aisle Airbus aircraft. Both small cap airlines have lost money since the pandemic. With so much in common, it makes sense that these two airlines, both focused on leisure travel, would join forces. Our only question is the price-tag: Frontier has agreed to buy Spirit in a deal valued at $6.6 billion—or around $1.7 billion more than the combined companies' market cap at the end of last week. If the merger is approved (it should be, but with the current DoJ, who knows), it would create the country's fifth-largest airline, behind American, Delta, Southwest, and United. We know that Frontier would control 51.5% of the merged company, with Spirit shareholders owning the other 48.5%. What has yet to be determined is who will be the CEO, what the entity will be called, and where it will be headquartered. Bill Franke, the current chair of Frontier and managing partner of parent company Indigo Parters, will remain in his role, however. Although its IPO was delayed due to the pandemic, Frontier finally went public on the NASDAQ last April, opening around $19 per share.
We like this deal a lot. In fact, it is fair to say that it needed to be done for the long-term viability of both companies. Both carriers have aggressive growth plans, and the combined entity should begin operations before the end of this year, just as leisure travel begins to take off once again. We wouldn't touch shares of either company, however, before the DoT/DoJ appear ready to give the green light to the merger. We own United Airlines Holdings (UAL $44) in the Penn Global Leaders Club.
Bear Market Chatter
The economy—and the markets—should be able to withstand the coming tightening cycle
Want an idea of how the markets might react to a multi-year series of rate hikes? Look no further than 2015 through 2018. In the three-year period between December of 2015 and December of 2018, the Fed initiated a total of nine, 25-basis-point hikes, taking the lower band of the Fed funds rate from 0% to 2.25%. That same scenario seems completely plausible this time around. Common sense test: It is rather difficult to imagine would-be home buyers proclaiming, "A 6% mortgage rate? That's it, we're out!" (6% is probably the max rates would spike to; they peaked at 4.94% during the last tightening cycle.)
Just as the last series of hikes didn't chase away buyers, it also didn't run off investors. Sure, we had that ugly fourth-quarter downturn in 2018 which culminated in a negative year, but that was the result of trade tensions, D.C.'s battle with big tech, and a host of other concerning headlines. By April of 2019, the Q4 losses had been erased, and the markets were off to the races once again—at least until a global pandemic entered the field.
Yes, piloting a so-called "soft landing" of the economy is going to require some finesse by the Fed, but we don't buy the current narrative that inflation is so out of control that it cannot be subdued. Supply chain issues will abate this year, higher rates will help dampen the unbridled enthusiasm which has pushed up the cost of new and used vehicles and homes, and technology will continue to put downward pressure on prices. Add needed tightening to the mix and we can make a good argument for a decent year ahead, especially after the market's recent pullback. We retain our 5,100 target price for the S&P 500 (which is suddenly sounding a lot better), with the caveat that we are due a negative year—much like the one we had in 2018.
Quantitative tightening will probably continue into 2023 and then end at some point in the year. The Fed should be able to whittle its balance sheet down to a more manageable (yet still unacceptable) $7 trillion or so. We do see a recession on the horizon, but that will most likely come to pass in the second half of 2023 or in the election year of 2024.
Monetary Policy
The Bank of America analyst who predicted seven rate hikes this year isn't too concerned about the tightening yield curve
We just explained why investors shouldn't be overly concerned with a series of rate hikes, but what about concern over the flattening yield curve? Many economists are wringing their hands over the tightening spread between the 2-year Treasury and the 10-year Treasury, with some seemingly wired to believe that an inverted curve (the blue line on the chart going below 0.00%) signals a recession is all but guaranteed. Ironically, we turn to someone whose rate hike predictions we don't buy to explain why this is not necessarily the case. There's an old joke—at the expense of economists—which says, "The yield curve has predicted eight out of the last four recessions." Funny. Bank of America's head of global economics, who is calling for seven hikes in 2022 and another four in 2023, made an interesting observation about the tightening curve. He argues that foreign investors are flooding in to buy 10-year US Treasuries because they are faced with zero—or even negative—rates back home. That is a great point. As demand goes up for the longer notes, the law of supply and demand says prices will naturally go up. In Bond World, high demand and higher prices means yields will naturally fall. Picture the teeter-totter rule of bonds. The longer the maturity, the further out on the teeter-totter the bonds sit. On the opposite side of price for any given maturity sits yield. In other words, as prices go up, yields come down, and the longer the duration or maturity, the faster this takes place. Yes, the Fed will raise rates, but they can only affect the short end, sitting nearest the fulcrum on our imaginary piece of playground equipment. This is certainly one strong explanation for the tightening curve. For the record, the B of A analyst, Ethan Harris, also believes that inflation will come down naturally to the 3% range or so in the not-too-distant future as a result of supply constraints easing and the economy getting back to more normal levels. So, we agree with everything he is espousing except for the eleven rate hikes.
We are sticking with our prediction of four, 25-basis-point hikes this year, and four more in 2023; this would place the Fed funds rate at a quite accommodative 2%. If that rate freaks the market out, we have bigger concerns about the psyche of investors.
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
- George Washington was chosen as he was the Founding Father of the nation
- Thomas Jefferson was chosen to represent expansion, as the author of the Declaration of Independence and the promoter/signer of the Louisiana Purchase (which doubled the size of the US)
- Theodore Roosevelt was chosen because he represented conservation (he established 150 national forests, 50 federal bird reserves, 4 national game preserves, 5 national parks, and 18 national monuments on over 230 million acres of newly-protected land)
- Abraham Lincoln was chosen for leading the United States through the bloody Civil War and his belief that the nation "must be preserved at any cost."
Headlines for the Week of 30 Jan 2022 — 05 Feb 2022
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Whose GDP is this anyway?..
America has, far and away, the world's largest GDP, currently at $23 trillion. China comes in second, at $17 trillion. But there is an interesting aspect to a nation's gross domestic product which we seldom take into consideration. Consider this question: If an American firm has $100 billion in revenue in one year, but $50 billion worth of that firm's products were sourced, assembled, and packaged in China, is the full $100 billion still added to US GDP? Hint: it doesn't matter where the products were sold.
Penn Trading Desk:
Penn: Power generation: The past meets the future in one company
We have removed FedEx (FDX $246) from the Penn Global Leaders Club and added a legacy power generation company which is embracing the future of the industry. We are very bullish on this well-known mid-cap stalwart, and have placed a price target on the shares 96% above our purchase price.
Penn: Add lower beta telecom player to the Strategic Income Portfolio
We continue to make moves in preparation for six to eight inevitable rate hikes over the next two years. To that end, we have replaced a bond fund in the Strategic Income Portfolio with a fat-yielding and undervalued equity position. Guard your fixed income holdings carefully in this environment.
Penn: Close Baird Aggregate Bond Fund in Strategic Income Portfolio
The Baird Aggregate Bond Fund (BAGSX $12) is the fund referenced above which we have liquidated. With around 1,500 securities, allocated about equally between government, corporate, and securitized notes, it is well diversified; however, its intermediate nature and effective duration of seven concerns us as we move into an interest rate hike cycle. Closed to purchase new position.
Penn: Add Natural Resources Fund to Dynamic Growth Strategy
Executing on one of our themes for 2022, the need to own "real assets" in the face of growing inflation, we have added a global upstream natural resources ETF to the Dynamic Growth Strategy. This investment focuses on real assets within five upstream industries: Energy, Metals, Agriculture, Timber, and Water.
Penn: Close XLC in Dynamic Growth Strategy
To make room for our natural resources holding, we closed our 3% position in XLC, the Communication Services Select Sector SPDR, and shaved 1% from each of our two health care positions, placing 5% in the new holding.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Microsoft is making an enormous bet on the future of gaming, and it aims to be the dominant player*
We are not sure how many times the world’s second largest company (by market cap), Microsoft (MSFT $295), can successfully reinvent itself, but all we can say is thank goodness Satya Nadella is at the helm rather than the “scholarly” Bill Gates. Not one to rest on its laurels or legacy products and services, the $2.3 trillion company just made its biggest purchase ever, and signaled its intent to embrace the future of gaming and the metaverse. With its $95 per share ($68.7B) purchase of Activision Blizzard (ATVI $81), Microsoft will leapfrog over a number of players to become the third-largest gaming company in the world by revenue, behind only Tencent Holdings and Sony (SONY $112). Once the deal is complete, Microsoft plans to fold as many of Activision's hugely-popular games into its Game Pass subscription, which boasts some 25 million paying subscribers. These include: World of Warcraft, Call of Duty, and Candy Crush. While the Game Pass numbers are impressive, they pale in comparison to Activision Blizzard's 400 million monthly active users; talk about a lucrative prospect list. Yes, the deal is going to face headwinds via a suddenly hostile FTC and DoJ, not to mention the always-hostile (against US firms) EU regulators, but we expect it to ultimately be approved.
Sony may end up being the odd player out, as the company's main console competitor will take ownership of PlayStation's most popular content, like Call of Duty. Accordingly, Sony shares plunged double digits following the announcement. Microsoft is a longstanding member of the Penn Global Leaders Club. (Update: Sony has subsequently announced its plans to acquire Halo and Destiny creator Bungie in a $3.6 billion deal. It should be noted that the Halo franchise itself is owned by Microsoft and is not available on the PlayStation.)
Media & Entertainment
09. Take-Two Interactive Software to buy Zynga in a $12.7 billion deal
Take-Two Interactive Software (TTWO $143), the $16 billion maker of such online games as "Grand Theft Auto" and "Red Dead Redemption," announced plans to buy mobile gaming developer Zynga (ZNGA $8) in a $12.7 billion deal. Zynga shareholders will receive $3.50 in cash and $6.36 in stock, or just shy of $10 per share. Not bad, considering Zynga shares were trading at $6 prior to the deal's announcement. The acquisition is part of a major push by Take-Two's outstanding CEO, Strauss Zelnick, to increase the company's footprint in the lucrative world of mobile gaming. According to WedBush analyst Michael Pachter, the deal should move the company's product mix from 10% mobile (gaming) to over 50% mobile, making it a major player in the space for the first time. Zynga generated $2 billion in revenue in 2020 and $2.7 billion in revenue over the trailing twelve months, yet it recorded a net loss of $90 million TTM.
With the deal, Take-Two should find itself in a better position to compete with larger rivals like Electronic Arts (EA $129). While we like the move, opinions on the Street are quite mixed. We would value TTWO shares at $200, or 40% higher from here, while our favorite player was Activision Blizzard, which we will soon own (pending approval) via our Microsoft holding.
Bear Market Chatter
08. Permabear Jeremy Grantham says stocks are in a superbubble, sees benchmark falling nearly 50%*
We are not a fan of permabears—individuals who chronically predict that the stock market sky is falling. We liken them to the man who had engraved on his tombstone, “I told you I was sick.” When major corrections do manifest, they are always there to take credit for “bravely” making the calls while the world fiddled. This leads us to Jeremy Grantham, the British billionaire investor and co-founder of GMO, a Boston-based asset management firm. Grantham has reissued his proclamation, first expressed before last year’s massive market run-up, that we are in the fourth superbubble of the past 100 years—the last three being the Stock Market Crash of 1929, the dot-com bubble of 2000, and the financial meltdown of 2008. Just how much does Grantham predict the markets will fall? For the S&P 500, on which we have a year-end price target of 5,100, he is calling for a level around 2,500. That would represent just shy of a 50% drop from its early January peak. As was the case with the tech bubble burst, he believes the drop could be substantially greater for the NASDAQ. In dollars and cents, Grantham notes, this could equate to the loss of some $35 trillion worth of wealth. While we actually agree with some of the rationale for his doomsday call (irresponsible fiscal and investor behavior, for the most part), we don't agree with his conclusion. Corrections have a way of sobering investor sentiment, and the lack of pullbacks since March of 2020 have led to overconfidence in high-flying equities with little to show in the way of earnings. We are due a normal, natural, garden variety downturn—the kind we used to get quadrennially; but nothing to the extent which Grantham is predicting.
America’s $30 trillion national debt and annual budget-busting deficits are another story. In that respect, we do believe the piper will have to be paid one of these days; just not in 2022.
National Debt
07. The national debt, Fed balance sheet, budget deficit, and GDP: a quick and dirty guide
When the terms national debt, budget deficit, Fed balance sheet, and GDP are thrown around, we suspect that many Americans' eyes tend to gloss over. However, just as every American family should know its financial position at any point in time, it is our duty to understand the basics of how the government is spending our money. Spoiler alert: it is not pretty. Let's start with the national debt, the most eye-popping of figures. As of right now, per USDebtClock.org, the United States is indebted to the tune of $30 trillion. We have been hearing a lot about the Fed's balance sheet lately, which currently adds up to just shy of $9 trillion. The "good news" is that this amount, which is a combination of mostly Treasuries and mortgage-backed securities, is included in the $30 trillion national debt. The Fed has already begun tapering its massive spending program, and aims to actually begin reducing that $9 trillion this year. Per a recent CNBC business survey, the general consensus is that the Fed should be able to reduce its balance sheet by $2.8 trillion over three years, which would bring the total down to roughly $6 trillion. Sadly, that is still well ahead of the $4.3 trillion on its books just prior to the pandemic.
So, this means that our federal debt should be reduced by $3 trillion as well, right? Not exactly. The government has estimated that it will receive $4.2 trillion in revenue in fiscal 2022. Unfortunately, the nonpartisan Congressional Budget Office predicts that, out of the $4.2 trillion in revenue, the government will actually spend approximately $6 trillion. This is fully legal, as there is no "balanced budget" amendment in the US Constitution. This means that, in one single year, the United States will have a budget deficit of $1.8 trillion, more that offsetting the Fed's planned balance sheet reduction. Of course, interest must be paid on any debt load ("servicing the debt"). A full 7.3% of all revenue collected by the US government, or some $305 billion, will be needed to service the national debt this year. And that is with historically-low interest rates. As interest rates rise, that 7.3% will grow, and grow, and grow.
Gross Domestic Product, or GDP, measures the total value of goods and services produced in a country in a single year. For the United States, that figure is sitting right at $23 trillion—far ahead of second place you-know-who, and certainly the envy of the world. The debt-to-GDP ratio is easily determined by dividing the amount of debt a country owes by the amount of its GDP in a given year. For historical perspective, America's debt-to-GDP ratio at the time of the Stock Market Crash of 1929 was 16%; upon entering World War II it was 44%; during the 1973 oil embargo it was 33%; and during the 9/11 attacks it was 55%. In 2012, something ominous happened; an economic "death cross," if you will. That is the year our national debt overtook—chronically and perennially—our GDP. Right now, America's debt-to-GDP ratio sits at 130%, and projections have that figure steadily rising over the coming years. For comparison, Venezuela's ratio is 214% and the United Kingdom's is 85%. China's debt-to-GDP ratio in 2021, according to the IMF, was roughly 70%. That country has responded by growing its spending by the weakest rate (0.3% y/y) in nearly two decades—a feat much more easily accomplished in a one-party communist dictatorship than in a representative republic.
And there we have it: a quick and dirty guide to federal debt, balance sheets, budget deficits, and GDP. Understanding these numbers and ratios is the first step in solving the problem. The next step is actually admitting that these numbers represent an unacceptable condition and will ultimately lead to an existential national threat. The third and fourth steps involve brainstorming for solutions and then implementing actions which will increase income and reduce expenditures. It is time to hold those in charge of the national credit cards accountable for their actions, and to demand more responsible behavior. But that would take yet another "stick" (in addition to a balanced budget amendment) in the form of mandatory term limits.
Consumer Electronics
06. A shot in the arm to a battered market: Apple delivers a blowout quarter
It has certainly been an ugly month for stocks, especially the formerly high-flying NASDAQ. That benchmark suddenly finds itself in correction territory and just three percentage points away from a bear market—down 17% from its November, 2021 highs. Fortunately, the index's top holding, Apple (AAPL $168), just came riding to the rescue. Despite facing severe parts shortages which have hampered production, the company shattered its old record by generating $123.9 billion in revenue in the last quarter of 2021, with $34.6 billion of that flowing down as pure profit. Analysts had lofty goals for the company's quarter; those estimates were easily surpassed. Apple's leading revenue generator, the iPhone, accounted for $71.6 billion of revenue—up 9.2% from the same period last year, while services revenue rose 23.8%, to $19.5 billion. Perhaps the biggest surprise came from Mac sales, which grew 25% from a year ago. While Mac accounts for just 10% of revenue, the move to an internally-produced M1 chip (dumping Intel's products) seems to have been a brilliant move. Geographically, sales grew robustly in every region. Despite America's ongoing trade disputes with China, Apple's $25.8 billion in sales from that country represented a 21% jump from last year. Morningstar analysts must have been impressed, as they raised their fair value on AAPL shares from $124 to $130 (insert eye rolling emoji here).
There are very few remaining "buy and hold" companies out there, as lackluster "managers" have taken over many of the offices where visionaries once sat. (Boeing, McDonald's, and Disney immediately come to mind.) Granted, were Steve Jobs still around we might have a few more super-cool gadgets to play with right now, but Tim Cook has been masterful at the helm. While Jobs wouldn't be happy with the Apple TV in its current form (he claimed to have "broken the TV code" shortly before his demise), the company is working on a number of exciting projects—like AR/VR hardware—which will help fuel future growth. A recurring stream of revenue from the company's 785 million subscribers (up 165 million from a year ago) doesn't hurt, either. Don't listen to the vacillating analysts—hold your Apple shares.
Application & Systems Software
05. Bakkt Holdings: Talk about a really, really bad time to go public
In August of 2018, the Intercontinental Exchange (ICE $124) formed a new company called Bakkt (pron. "backed," as in asset-backed securities) designed to give consumers, businesses, and institutions the ability to make transactions with digital assets such as cryptos, airline miles, and gift cards. The idea made sense: one simple digital wallet to securely transact with and store one's digital assets on an advanced app. ICE decided to take its creation public via a SPAC (uh oh, first sign of trouble) back in October of last year under the symbol BKKT. Before the month was up, a deal was announced between Mastercard (MA $383) and Bakkt Holdings which would allow the second-largest payments processor in the world to offer and accept crypto payments using the tech company's platform. BKKT shares skyrocketed over 500% virtually overnight, from around $8 to an intraday high of $50.80 on the first day of November. Investors should have taken that insane spike as an excuse to put a stop-loss on their position, if not selling it outright and waiting for it to fall back to earth. And fall back it did, riding the tech correction all the way down. The $2 billion company is now worth $195 million, and its shares have "rallied" back up to $3.61 as of Friday's close. The chart, quite frankly, looks like something out of the 1999 to 2001 timeframe. One difference: we do expect this tech company to stick around, unlike so many from that era.
For anyone just discovering this micro-cap tech infrastructure play, is it worth nibbling at after its massive fall? Only with money that wouldn't be missed, and certainly with a stop-loss order in place. Morningstar has a fair value of $6.41 on the shares.
Goods & Services
04. Another argument for rate hikes and Fed balance sheet reduction: Q4's strong GDP figures
Much of January's market correction could be placed at the feet of the Fed's well-telegraphed pending rate hikes, but does the American economy really need near-zero interest rates any longer to sustain growth? Not according to one very important economic metric. Fourth quarter GDP numbers are in, and they easily surpassed all expectations. Against economists' predictions calling for a growth rate of 5.5% annualized in Q4, the aggregate of all goods and services produced in the US for the last three months of the year actually grew by 6.9%. With four quarters now in the books, we have our preliminary read on 2021's US GDP: 5.7%. How good is that? The figure is over double the ten-year average growth rate of 2.47%, and represents the strongest full year growth since 1984. Impressively, the gains were brought about by a dual springboard of higher consumer activity and increased business spending—all while government spending decreased. Considering the supply chain issues which hampered growth in the fourth quarter, we see economic growth remaining strong throughout 2022 as these issues slowly abate.
The United States accounts for 25% of the world's $95 trillion economy, with China coming in second place at 17% (See graph). It is interesting to note that we have passed the date by which many economists and business journalists told us that China would surpass America as the world's largest economy. Of course, they made these projections based on the faulty logic that an emerging market economy could sustain a double-digit growth rate as its economy grew. Additionally, with global companies finally diversifying their country risk away from China, that imaginary no-later-than date has been moved out even further.
Aerospace & Defense
03. Now that the heavy hand of the government has come down on the deal, what happens to Aerojet Rocketdyne?
We are invested in this story, literally. Lockheed Martin (LMT $387) is a longstanding member of the Penn Global Leaders Club and one of our top picks for 2022; Aerojet Rocketdyne (AJRD $38) is a member of the Penn New Frontier Fund and a key US supplier of aerospace and defense systems—to include highly-advanced hypersonic propulsion technology. In a move that made brilliant sense, the former agreed to buy the latter back in December of 2020 for the equivalent of $56 per share, or $4.4 billion. Now, the Darth Vader of American business, the Federal Trade Commission's Lina Khan, is suing to block the deal. (Well, the FTC is suing, but this was obviously spearheaded by the anti-business—in our opinion—new chair of the Commission). Khan, who received her J.D. from Yale just five years ago and was a law professor at Columbia University before accepting the FTC position, has clearly signaled her disdain for large American corporations. The FTC claims that Lockheed would use its control of Aerojet to hurt its rivals, but can the purchase of one small-cap rocket maker really put the industry in tumult? Of course not. Furthermore, it is highly likely that a European firm would swoop in and buy AJRD without the FTC lifting a finger. If Lockheed's ownership of the company would affect the competitive landscape for the defense industry, wouldn't foreign ownership be even worse? We knew Khan would do her best to wreak havoc on the American business landscape; consider this the first shot of many more to come.
We would like to say that the combination of Aerojet Rocketdyne's critical technology and recent share price plummet equates to a unique opportunity for investors, but something else is going on within the company which concerns us. There is a battle forming between the company's innovative leadership team, led by CEO Eileen Drake, and an activist movement spearheaded by private equity investor and Executive Chairman Warren Lichtenstein. We believe that Drake, a distinguished graduate of the US Army Aviation Officer School, is intent on maintaining industry leadership for a standalone Aerojet, while Lichtenstein, true to his nature, is intent on engineering a takeover of the firm by another player. Our hopes are that Drake prevails, but the internecine battle could cause further damage to the share price.
Interactive Media & Services
02. Alphabet's blowout quarter and a 20-for-1 stock split makes the company look even more attractive
The $2 trillion holding company of Google, Alphabet (GOOG $2,961), just announced its best quarter ever, easily blowing away pretty hefty expectations for the period. Analysts had predicted revenues of $72.3 billion and earnings of $27.68 per share; instead, the company reported Q4 revenues of $75.3 billion and EPS of $30.69. As if that weren't enough, CFO Ruth Porat announced plans for a 20-for-1 stock split, making the company more attractive to a wider swath of investors and raising the odds that it will soon be included in the Dow Jones Industrial Average. The revenue windfall amounted to a 32% increase from the same quarter last year, and was buoyed by advertising sales of $61 billion. The company's YouTube business, which boasts some 15 billion views per day, accounted for $8.63 billion in sales. The company is far and away the hottest destination for digital advertising dollars, which accounts for some 80% of total revenue, but it also wants to diversify its offerings. Although it barely makes a mark in the lucrative cloud computing business, an area dominated by Amazon Web Services and Microsoft Azure, the company is investing heavily to grow its 6% stake. Google has tapped into its over $140 billion stash of cash, for example, to buy an equity stake in Chicago-based exchange CME Group (CME $241) in return for the company's long-term cloud contracts. This seems like a natural arena for the Internet media giant, and the cloud services pie is only getting bigger. As for other opportunities to widen its scope, recall that Google changed its name to Alphabet for a reason. From the metaverse to self-driving vehicles (it bought autonomous driving tech company Waymo in 2016), we expect the skilled team of CEO Sundar Pichai and CFO Ruth Porat to continue generating stunning quarterly results for investors.
We have figuratively banged our heads against the wall trying to explain to certain clients over the years that just because a stock is priced at $10 per share, it is no more undervalued (all other facets being equal) than if the shares were selling for $10,000 apiece. Nonetheless, while the stock split will not add one cent of value, we do applaud the move. Psychology is a powerful tool to use when analyzing investor behavior. Based on the company's current share price, it would be trading around $150 per share were the split completed today. Rather than saying Google shares are worth $6,000 each, let's just say we could see them growing from $150 to $300 in a reasonable amount of time post split.
Market Pulse
01. As goes January, so goes the year? Hopefully not
Even with a nice rally on the final trading day of the month, January was messy. In fact, it turned out to be the worst start to a year since the global financial crisis. For tech stocks, as benchmarked by the NASDAQ, it was even worse: the index had its second-poorest opening month of the year since its inception. But even the NASDAQ performed better than the small caps, which briefly entered bear market territory with their 20.94% drop from November highs. (The NASDAQ skirted a bear market, missing by three percentage points.) It was not quite as bad for the Dow and S&P 500, which fell as much as 7% and 10% from their highs, respectively. Was the month just a blip following a strong year, or do we believe the old "as goes January, so goes the month" adage?
Let's begin by analyzing the catalysts—other than a strong preceding year—for the downturn. Overwhelmingly, it was the Fed (rate hikes), the Russians (potential invasion of the Ukraine), and concerns over weakening earnings. For the tech stocks which were pandemic darlings, sky-high valuations are being reevaluated as the global workforce moves back, albeit slowly, into the office environment. We know what has happened to the Peloton's of the market, but consider this: shares of DocuSign (DOCU $125) fell 60% from their high price, while Zoom Video (ZM $151) fell 76% from October highs. It was the worst overall month for the markets since March of 2020, which investors recall all too well. That period, however, turned out to be one of the best buying opportunities in the past decade. Time will tell whether or not January will have provided a similar opportunity.
While our buying spree is nothing like that of late spring/early summer of 2020, we have been picking up some deeply undervalued names. The selling was relatively indiscriminate, as witnessed by drops in the likes of Microsoft and Apple. While scouring for deals, look for companies with fat earnings, pricing and staying power, and nice dividend yields. Also, scan small-cap equities which are domestically focused; the drop in the Russell 2000 has presented some excellent buying opportunities. Finally, don't be afraid to put stop-loss orders on positions to protect gains or limit losses—there will be other chances to pick these companies back up at lower levels if warranted. And remember, cash is an asset class in which every investor should be allocated.
Under the Radar Investment
Mitsubishi Electric (MIELY $24)
We are bullish on Japanese equities in 2022, and have begun a top-down review of sectors, industries, and—subsequently—individual names based out of that country which we find attractive. One clear opportunity presents itself in $25 billion industrial firm Mitsubishi Electric. Think of the firm as the Japanese version of General Electric, without the milquetoast leadership (well, lack thereof) of the American firm. Founded 101 years ago, Mitsubishi is an electrical industrials conglomerate that develops, manufactures, distributes, and sells electrical equipment worldwide. With a low P/E ratio and beta, the company has annual sales of around $40 billion and perennially yields a fat net income. Going forward, we especially like the company's industrial automation systems division, which should play a major role in the global automation renaissance picking up steam. Mitsubishi also offers investors a decent dividend yield of 3%. We would give MIELY shares a fair value of $30.
Answer
Gross domestic product is the value of all goods and services produced in a country during one year. Therefore, if an American company produces goods at a foreign factory, the value of those goods adds to that country's GDP, not America's. Of course, the global supply chain is a complicated matter, as is clearly evident right now. An iPhone, for example, might be assembled in China, but with parts from around the world. Nonetheless, here is the point: Consider China's $17 trillion economy, and then consider what China's GDP would look like without foreign companies manufacturing their products within the country. The number is somewhat of an illusion.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Whose GDP is this anyway?..
America has, far and away, the world's largest GDP, currently at $23 trillion. China comes in second, at $17 trillion. But there is an interesting aspect to a nation's gross domestic product which we seldom take into consideration. Consider this question: If an American firm has $100 billion in revenue in one year, but $50 billion worth of that firm's products were sourced, assembled, and packaged in China, is the full $100 billion still added to US GDP? Hint: it doesn't matter where the products were sold.
Penn Trading Desk:
Penn: Power generation: The past meets the future in one company
We have removed FedEx (FDX $246) from the Penn Global Leaders Club and added a legacy power generation company which is embracing the future of the industry. We are very bullish on this well-known mid-cap stalwart, and have placed a price target on the shares 96% above our purchase price.
Penn: Add lower beta telecom player to the Strategic Income Portfolio
We continue to make moves in preparation for six to eight inevitable rate hikes over the next two years. To that end, we have replaced a bond fund in the Strategic Income Portfolio with a fat-yielding and undervalued equity position. Guard your fixed income holdings carefully in this environment.
Penn: Close Baird Aggregate Bond Fund in Strategic Income Portfolio
The Baird Aggregate Bond Fund (BAGSX $12) is the fund referenced above which we have liquidated. With around 1,500 securities, allocated about equally between government, corporate, and securitized notes, it is well diversified; however, its intermediate nature and effective duration of seven concerns us as we move into an interest rate hike cycle. Closed to purchase new position.
Penn: Add Natural Resources Fund to Dynamic Growth Strategy
Executing on one of our themes for 2022, the need to own "real assets" in the face of growing inflation, we have added a global upstream natural resources ETF to the Dynamic Growth Strategy. This investment focuses on real assets within five upstream industries: Energy, Metals, Agriculture, Timber, and Water.
Penn: Close XLC in Dynamic Growth Strategy
To make room for our natural resources holding, we closed our 3% position in XLC, the Communication Services Select Sector SPDR, and shaved 1% from each of our two health care positions, placing 5% in the new holding.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Microsoft is making an enormous bet on the future of gaming, and it aims to be the dominant player*
We are not sure how many times the world’s second largest company (by market cap), Microsoft (MSFT $295), can successfully reinvent itself, but all we can say is thank goodness Satya Nadella is at the helm rather than the “scholarly” Bill Gates. Not one to rest on its laurels or legacy products and services, the $2.3 trillion company just made its biggest purchase ever, and signaled its intent to embrace the future of gaming and the metaverse. With its $95 per share ($68.7B) purchase of Activision Blizzard (ATVI $81), Microsoft will leapfrog over a number of players to become the third-largest gaming company in the world by revenue, behind only Tencent Holdings and Sony (SONY $112). Once the deal is complete, Microsoft plans to fold as many of Activision's hugely-popular games into its Game Pass subscription, which boasts some 25 million paying subscribers. These include: World of Warcraft, Call of Duty, and Candy Crush. While the Game Pass numbers are impressive, they pale in comparison to Activision Blizzard's 400 million monthly active users; talk about a lucrative prospect list. Yes, the deal is going to face headwinds via a suddenly hostile FTC and DoJ, not to mention the always-hostile (against US firms) EU regulators, but we expect it to ultimately be approved.
Sony may end up being the odd player out, as the company's main console competitor will take ownership of PlayStation's most popular content, like Call of Duty. Accordingly, Sony shares plunged double digits following the announcement. Microsoft is a longstanding member of the Penn Global Leaders Club. (Update: Sony has subsequently announced its plans to acquire Halo and Destiny creator Bungie in a $3.6 billion deal. It should be noted that the Halo franchise itself is owned by Microsoft and is not available on the PlayStation.)
Media & Entertainment
09. Take-Two Interactive Software to buy Zynga in a $12.7 billion deal
Take-Two Interactive Software (TTWO $143), the $16 billion maker of such online games as "Grand Theft Auto" and "Red Dead Redemption," announced plans to buy mobile gaming developer Zynga (ZNGA $8) in a $12.7 billion deal. Zynga shareholders will receive $3.50 in cash and $6.36 in stock, or just shy of $10 per share. Not bad, considering Zynga shares were trading at $6 prior to the deal's announcement. The acquisition is part of a major push by Take-Two's outstanding CEO, Strauss Zelnick, to increase the company's footprint in the lucrative world of mobile gaming. According to WedBush analyst Michael Pachter, the deal should move the company's product mix from 10% mobile (gaming) to over 50% mobile, making it a major player in the space for the first time. Zynga generated $2 billion in revenue in 2020 and $2.7 billion in revenue over the trailing twelve months, yet it recorded a net loss of $90 million TTM.
With the deal, Take-Two should find itself in a better position to compete with larger rivals like Electronic Arts (EA $129). While we like the move, opinions on the Street are quite mixed. We would value TTWO shares at $200, or 40% higher from here, while our favorite player was Activision Blizzard, which we will soon own (pending approval) via our Microsoft holding.
Bear Market Chatter
08. Permabear Jeremy Grantham says stocks are in a superbubble, sees benchmark falling nearly 50%*
We are not a fan of permabears—individuals who chronically predict that the stock market sky is falling. We liken them to the man who had engraved on his tombstone, “I told you I was sick.” When major corrections do manifest, they are always there to take credit for “bravely” making the calls while the world fiddled. This leads us to Jeremy Grantham, the British billionaire investor and co-founder of GMO, a Boston-based asset management firm. Grantham has reissued his proclamation, first expressed before last year’s massive market run-up, that we are in the fourth superbubble of the past 100 years—the last three being the Stock Market Crash of 1929, the dot-com bubble of 2000, and the financial meltdown of 2008. Just how much does Grantham predict the markets will fall? For the S&P 500, on which we have a year-end price target of 5,100, he is calling for a level around 2,500. That would represent just shy of a 50% drop from its early January peak. As was the case with the tech bubble burst, he believes the drop could be substantially greater for the NASDAQ. In dollars and cents, Grantham notes, this could equate to the loss of some $35 trillion worth of wealth. While we actually agree with some of the rationale for his doomsday call (irresponsible fiscal and investor behavior, for the most part), we don't agree with his conclusion. Corrections have a way of sobering investor sentiment, and the lack of pullbacks since March of 2020 have led to overconfidence in high-flying equities with little to show in the way of earnings. We are due a normal, natural, garden variety downturn—the kind we used to get quadrennially; but nothing to the extent which Grantham is predicting.
America’s $30 trillion national debt and annual budget-busting deficits are another story. In that respect, we do believe the piper will have to be paid one of these days; just not in 2022.
National Debt
07. The national debt, Fed balance sheet, budget deficit, and GDP: a quick and dirty guide
When the terms national debt, budget deficit, Fed balance sheet, and GDP are thrown around, we suspect that many Americans' eyes tend to gloss over. However, just as every American family should know its financial position at any point in time, it is our duty to understand the basics of how the government is spending our money. Spoiler alert: it is not pretty. Let's start with the national debt, the most eye-popping of figures. As of right now, per USDebtClock.org, the United States is indebted to the tune of $30 trillion. We have been hearing a lot about the Fed's balance sheet lately, which currently adds up to just shy of $9 trillion. The "good news" is that this amount, which is a combination of mostly Treasuries and mortgage-backed securities, is included in the $30 trillion national debt. The Fed has already begun tapering its massive spending program, and aims to actually begin reducing that $9 trillion this year. Per a recent CNBC business survey, the general consensus is that the Fed should be able to reduce its balance sheet by $2.8 trillion over three years, which would bring the total down to roughly $6 trillion. Sadly, that is still well ahead of the $4.3 trillion on its books just prior to the pandemic.
So, this means that our federal debt should be reduced by $3 trillion as well, right? Not exactly. The government has estimated that it will receive $4.2 trillion in revenue in fiscal 2022. Unfortunately, the nonpartisan Congressional Budget Office predicts that, out of the $4.2 trillion in revenue, the government will actually spend approximately $6 trillion. This is fully legal, as there is no "balanced budget" amendment in the US Constitution. This means that, in one single year, the United States will have a budget deficit of $1.8 trillion, more that offsetting the Fed's planned balance sheet reduction. Of course, interest must be paid on any debt load ("servicing the debt"). A full 7.3% of all revenue collected by the US government, or some $305 billion, will be needed to service the national debt this year. And that is with historically-low interest rates. As interest rates rise, that 7.3% will grow, and grow, and grow.
Gross Domestic Product, or GDP, measures the total value of goods and services produced in a country in a single year. For the United States, that figure is sitting right at $23 trillion—far ahead of second place you-know-who, and certainly the envy of the world. The debt-to-GDP ratio is easily determined by dividing the amount of debt a country owes by the amount of its GDP in a given year. For historical perspective, America's debt-to-GDP ratio at the time of the Stock Market Crash of 1929 was 16%; upon entering World War II it was 44%; during the 1973 oil embargo it was 33%; and during the 9/11 attacks it was 55%. In 2012, something ominous happened; an economic "death cross," if you will. That is the year our national debt overtook—chronically and perennially—our GDP. Right now, America's debt-to-GDP ratio sits at 130%, and projections have that figure steadily rising over the coming years. For comparison, Venezuela's ratio is 214% and the United Kingdom's is 85%. China's debt-to-GDP ratio in 2021, according to the IMF, was roughly 70%. That country has responded by growing its spending by the weakest rate (0.3% y/y) in nearly two decades—a feat much more easily accomplished in a one-party communist dictatorship than in a representative republic.
And there we have it: a quick and dirty guide to federal debt, balance sheets, budget deficits, and GDP. Understanding these numbers and ratios is the first step in solving the problem. The next step is actually admitting that these numbers represent an unacceptable condition and will ultimately lead to an existential national threat. The third and fourth steps involve brainstorming for solutions and then implementing actions which will increase income and reduce expenditures. It is time to hold those in charge of the national credit cards accountable for their actions, and to demand more responsible behavior. But that would take yet another "stick" (in addition to a balanced budget amendment) in the form of mandatory term limits.
Consumer Electronics
06. A shot in the arm to a battered market: Apple delivers a blowout quarter
It has certainly been an ugly month for stocks, especially the formerly high-flying NASDAQ. That benchmark suddenly finds itself in correction territory and just three percentage points away from a bear market—down 17% from its November, 2021 highs. Fortunately, the index's top holding, Apple (AAPL $168), just came riding to the rescue. Despite facing severe parts shortages which have hampered production, the company shattered its old record by generating $123.9 billion in revenue in the last quarter of 2021, with $34.6 billion of that flowing down as pure profit. Analysts had lofty goals for the company's quarter; those estimates were easily surpassed. Apple's leading revenue generator, the iPhone, accounted for $71.6 billion of revenue—up 9.2% from the same period last year, while services revenue rose 23.8%, to $19.5 billion. Perhaps the biggest surprise came from Mac sales, which grew 25% from a year ago. While Mac accounts for just 10% of revenue, the move to an internally-produced M1 chip (dumping Intel's products) seems to have been a brilliant move. Geographically, sales grew robustly in every region. Despite America's ongoing trade disputes with China, Apple's $25.8 billion in sales from that country represented a 21% jump from last year. Morningstar analysts must have been impressed, as they raised their fair value on AAPL shares from $124 to $130 (insert eye rolling emoji here).
There are very few remaining "buy and hold" companies out there, as lackluster "managers" have taken over many of the offices where visionaries once sat. (Boeing, McDonald's, and Disney immediately come to mind.) Granted, were Steve Jobs still around we might have a few more super-cool gadgets to play with right now, but Tim Cook has been masterful at the helm. While Jobs wouldn't be happy with the Apple TV in its current form (he claimed to have "broken the TV code" shortly before his demise), the company is working on a number of exciting projects—like AR/VR hardware—which will help fuel future growth. A recurring stream of revenue from the company's 785 million subscribers (up 165 million from a year ago) doesn't hurt, either. Don't listen to the vacillating analysts—hold your Apple shares.
Application & Systems Software
05. Bakkt Holdings: Talk about a really, really bad time to go public
In August of 2018, the Intercontinental Exchange (ICE $124) formed a new company called Bakkt (pron. "backed," as in asset-backed securities) designed to give consumers, businesses, and institutions the ability to make transactions with digital assets such as cryptos, airline miles, and gift cards. The idea made sense: one simple digital wallet to securely transact with and store one's digital assets on an advanced app. ICE decided to take its creation public via a SPAC (uh oh, first sign of trouble) back in October of last year under the symbol BKKT. Before the month was up, a deal was announced between Mastercard (MA $383) and Bakkt Holdings which would allow the second-largest payments processor in the world to offer and accept crypto payments using the tech company's platform. BKKT shares skyrocketed over 500% virtually overnight, from around $8 to an intraday high of $50.80 on the first day of November. Investors should have taken that insane spike as an excuse to put a stop-loss on their position, if not selling it outright and waiting for it to fall back to earth. And fall back it did, riding the tech correction all the way down. The $2 billion company is now worth $195 million, and its shares have "rallied" back up to $3.61 as of Friday's close. The chart, quite frankly, looks like something out of the 1999 to 2001 timeframe. One difference: we do expect this tech company to stick around, unlike so many from that era.
For anyone just discovering this micro-cap tech infrastructure play, is it worth nibbling at after its massive fall? Only with money that wouldn't be missed, and certainly with a stop-loss order in place. Morningstar has a fair value of $6.41 on the shares.
Goods & Services
04. Another argument for rate hikes and Fed balance sheet reduction: Q4's strong GDP figures
Much of January's market correction could be placed at the feet of the Fed's well-telegraphed pending rate hikes, but does the American economy really need near-zero interest rates any longer to sustain growth? Not according to one very important economic metric. Fourth quarter GDP numbers are in, and they easily surpassed all expectations. Against economists' predictions calling for a growth rate of 5.5% annualized in Q4, the aggregate of all goods and services produced in the US for the last three months of the year actually grew by 6.9%. With four quarters now in the books, we have our preliminary read on 2021's US GDP: 5.7%. How good is that? The figure is over double the ten-year average growth rate of 2.47%, and represents the strongest full year growth since 1984. Impressively, the gains were brought about by a dual springboard of higher consumer activity and increased business spending—all while government spending decreased. Considering the supply chain issues which hampered growth in the fourth quarter, we see economic growth remaining strong throughout 2022 as these issues slowly abate.
The United States accounts for 25% of the world's $95 trillion economy, with China coming in second place at 17% (See graph). It is interesting to note that we have passed the date by which many economists and business journalists told us that China would surpass America as the world's largest economy. Of course, they made these projections based on the faulty logic that an emerging market economy could sustain a double-digit growth rate as its economy grew. Additionally, with global companies finally diversifying their country risk away from China, that imaginary no-later-than date has been moved out even further.
Aerospace & Defense
03. Now that the heavy hand of the government has come down on the deal, what happens to Aerojet Rocketdyne?
We are invested in this story, literally. Lockheed Martin (LMT $387) is a longstanding member of the Penn Global Leaders Club and one of our top picks for 2022; Aerojet Rocketdyne (AJRD $38) is a member of the Penn New Frontier Fund and a key US supplier of aerospace and defense systems—to include highly-advanced hypersonic propulsion technology. In a move that made brilliant sense, the former agreed to buy the latter back in December of 2020 for the equivalent of $56 per share, or $4.4 billion. Now, the Darth Vader of American business, the Federal Trade Commission's Lina Khan, is suing to block the deal. (Well, the FTC is suing, but this was obviously spearheaded by the anti-business—in our opinion—new chair of the Commission). Khan, who received her J.D. from Yale just five years ago and was a law professor at Columbia University before accepting the FTC position, has clearly signaled her disdain for large American corporations. The FTC claims that Lockheed would use its control of Aerojet to hurt its rivals, but can the purchase of one small-cap rocket maker really put the industry in tumult? Of course not. Furthermore, it is highly likely that a European firm would swoop in and buy AJRD without the FTC lifting a finger. If Lockheed's ownership of the company would affect the competitive landscape for the defense industry, wouldn't foreign ownership be even worse? We knew Khan would do her best to wreak havoc on the American business landscape; consider this the first shot of many more to come.
We would like to say that the combination of Aerojet Rocketdyne's critical technology and recent share price plummet equates to a unique opportunity for investors, but something else is going on within the company which concerns us. There is a battle forming between the company's innovative leadership team, led by CEO Eileen Drake, and an activist movement spearheaded by private equity investor and Executive Chairman Warren Lichtenstein. We believe that Drake, a distinguished graduate of the US Army Aviation Officer School, is intent on maintaining industry leadership for a standalone Aerojet, while Lichtenstein, true to his nature, is intent on engineering a takeover of the firm by another player. Our hopes are that Drake prevails, but the internecine battle could cause further damage to the share price.
Interactive Media & Services
02. Alphabet's blowout quarter and a 20-for-1 stock split makes the company look even more attractive
The $2 trillion holding company of Google, Alphabet (GOOG $2,961), just announced its best quarter ever, easily blowing away pretty hefty expectations for the period. Analysts had predicted revenues of $72.3 billion and earnings of $27.68 per share; instead, the company reported Q4 revenues of $75.3 billion and EPS of $30.69. As if that weren't enough, CFO Ruth Porat announced plans for a 20-for-1 stock split, making the company more attractive to a wider swath of investors and raising the odds that it will soon be included in the Dow Jones Industrial Average. The revenue windfall amounted to a 32% increase from the same quarter last year, and was buoyed by advertising sales of $61 billion. The company's YouTube business, which boasts some 15 billion views per day, accounted for $8.63 billion in sales. The company is far and away the hottest destination for digital advertising dollars, which accounts for some 80% of total revenue, but it also wants to diversify its offerings. Although it barely makes a mark in the lucrative cloud computing business, an area dominated by Amazon Web Services and Microsoft Azure, the company is investing heavily to grow its 6% stake. Google has tapped into its over $140 billion stash of cash, for example, to buy an equity stake in Chicago-based exchange CME Group (CME $241) in return for the company's long-term cloud contracts. This seems like a natural arena for the Internet media giant, and the cloud services pie is only getting bigger. As for other opportunities to widen its scope, recall that Google changed its name to Alphabet for a reason. From the metaverse to self-driving vehicles (it bought autonomous driving tech company Waymo in 2016), we expect the skilled team of CEO Sundar Pichai and CFO Ruth Porat to continue generating stunning quarterly results for investors.
We have figuratively banged our heads against the wall trying to explain to certain clients over the years that just because a stock is priced at $10 per share, it is no more undervalued (all other facets being equal) than if the shares were selling for $10,000 apiece. Nonetheless, while the stock split will not add one cent of value, we do applaud the move. Psychology is a powerful tool to use when analyzing investor behavior. Based on the company's current share price, it would be trading around $150 per share were the split completed today. Rather than saying Google shares are worth $6,000 each, let's just say we could see them growing from $150 to $300 in a reasonable amount of time post split.
Market Pulse
01. As goes January, so goes the year? Hopefully not
Even with a nice rally on the final trading day of the month, January was messy. In fact, it turned out to be the worst start to a year since the global financial crisis. For tech stocks, as benchmarked by the NASDAQ, it was even worse: the index had its second-poorest opening month of the year since its inception. But even the NASDAQ performed better than the small caps, which briefly entered bear market territory with their 20.94% drop from November highs. (The NASDAQ skirted a bear market, missing by three percentage points.) It was not quite as bad for the Dow and S&P 500, which fell as much as 7% and 10% from their highs, respectively. Was the month just a blip following a strong year, or do we believe the old "as goes January, so goes the month" adage?
Let's begin by analyzing the catalysts—other than a strong preceding year—for the downturn. Overwhelmingly, it was the Fed (rate hikes), the Russians (potential invasion of the Ukraine), and concerns over weakening earnings. For the tech stocks which were pandemic darlings, sky-high valuations are being reevaluated as the global workforce moves back, albeit slowly, into the office environment. We know what has happened to the Peloton's of the market, but consider this: shares of DocuSign (DOCU $125) fell 60% from their high price, while Zoom Video (ZM $151) fell 76% from October highs. It was the worst overall month for the markets since March of 2020, which investors recall all too well. That period, however, turned out to be one of the best buying opportunities in the past decade. Time will tell whether or not January will have provided a similar opportunity.
While our buying spree is nothing like that of late spring/early summer of 2020, we have been picking up some deeply undervalued names. The selling was relatively indiscriminate, as witnessed by drops in the likes of Microsoft and Apple. While scouring for deals, look for companies with fat earnings, pricing and staying power, and nice dividend yields. Also, scan small-cap equities which are domestically focused; the drop in the Russell 2000 has presented some excellent buying opportunities. Finally, don't be afraid to put stop-loss orders on positions to protect gains or limit losses—there will be other chances to pick these companies back up at lower levels if warranted. And remember, cash is an asset class in which every investor should be allocated.
Under the Radar Investment
Mitsubishi Electric (MIELY $24)
We are bullish on Japanese equities in 2022, and have begun a top-down review of sectors, industries, and—subsequently—individual names based out of that country which we find attractive. One clear opportunity presents itself in $25 billion industrial firm Mitsubishi Electric. Think of the firm as the Japanese version of General Electric, without the milquetoast leadership (well, lack thereof) of the American firm. Founded 101 years ago, Mitsubishi is an electrical industrials conglomerate that develops, manufactures, distributes, and sells electrical equipment worldwide. With a low P/E ratio and beta, the company has annual sales of around $40 billion and perennially yields a fat net income. Going forward, we especially like the company's industrial automation systems division, which should play a major role in the global automation renaissance picking up steam. Mitsubishi also offers investors a decent dividend yield of 3%. We would give MIELY shares a fair value of $30.
Answer
Gross domestic product is the value of all goods and services produced in a country during one year. Therefore, if an American company produces goods at a foreign factory, the value of those goods adds to that country's GDP, not America's. Of course, the global supply chain is a complicated matter, as is clearly evident right now. An iPhone, for example, might be assembled in China, but with parts from around the world. Nonetheless, here is the point: Consider China's $17 trillion economy, and then consider what China's GDP would look like without foreign companies manufacturing their products within the country. The number is somewhat of an illusion.
Headlines for the Week of 19 Dec — 25 Dec 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Best stock of 1999...
In some ways, 2021 reminds us of 1999. High-tech companies with a lack of profitability as far as the eye can see, speculative investments which seem impervious to fundamental analysis, new platforms bringing trading to the masses. Looking back to 1999, what would have been the best investment (outside of some goofy answer, like the Puerto Rican Cement Company—a high-flying penny stock back in the day) of that year? Hint: it not only still exists, but we own it within our strategies.
Penn Trading Desk:
Oppenheimer: Coinbase listed as a top stock pick for 2022
Oppenheimer has named Penn strategies member Coinbase (COIN $250) as one of its top picks for 2022. The company cited continued and widespread adoption of digital assets as a form of payment, both by retailers and institutions, as rationale for their rating. Coinbase, which is a member of the Penn Intrepid Trading Platform, is a major cryptocurrency exchange allowing for the purchase of hundreds of different cryptocurrencies, as well as the ability to make transactions with these currencies directly from the platform's digital wallet. Oppenheimer has an Outperform rating on the company with a price target of $444 on COIN shares—or 77% higher from here.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecommunication Services
10. US recommends approval of a massive Meta/Google undersea cable project in Asia; China is not amused
The Biden administration has recommended that the FCC grant Meta (FB $334) and Alphabet (GOOG $2,856) licenses to build a 12,000-kilometer-long (7,500 miles) network of undersea fiber optic cables spanning a number of Asian countries—sans China. The effort, known as Project Apricot, will connect Singapore, Japan, Guam, the Philippines, Taiwan, and Indonesia in an effort to bring reliable, high-speed Internet access to portions of the world both underserved and over-reliant on Communist China for their connectivity. The Apricot project will compliment Project Echo, connecting the US with Singapore, Guam, and Indonesia. The ultimate goal, according to Google VP of Global Networking Bikash Koley, is to create multiple (digital) paths in and out of Asia, and "increased resilience in connectivity between Southeast Asia, North Asia, and the United States." A previous joint project to build an undersea cable connecting California and Hong Kong was scrapped by Google and Meta—upon a US Department of Justice recommendation—due to US/Sino tensions. Technology, coupled with gutsy leadership, is making it harder for repressive regimes to constrict the free flow of information, thus controlling the narrative. Needless to say, Beijing is not happy with this project, which is slated to be completed by 2023.
The more China is backed into a corner, the more evident it will become to the free world precisely what the CCP's long-term goals are, and how incompatible they are with the pursuit of human freedom. The West may have a short memory, but we can count on China's ruling communist elites to keep stoking the fire. In the end, freedom always wins.
Renewables
09. Solar stocks are getting crushed on the back of new California proposals
Interesting, coming from the state which claims to be on the vanguard of societal evolution (smirk). The once-darling solar stocks, names like Sunrun (RUN $32), First Solar (FSLR $86), EnPhase Energy (ENPH $180), and SolarEdge Technologies (SEDG $263), have been plummeting since California proposed new rules which would make it more costly for families to put solar panels on their roofs. At the heart of the issue are the California utilities, which don't like the competition from the bourgeois middle class of the state who dare to generate their own household power. These utility concerns, working through the California Public Utilities Commission, wish to extort a monthly "grid fee" from anyone with the panels on their roofs, and they want to reduce the amount of payout for the power coming back to the grid from solar sources. While these recommendations must still be codified by state legislators, the threat was enough to sink the shares of major players. California-based Sunrun, for example, has seen its share price drop by two-thirds since January. One hopeful sign: the commissioner who penned the proposal will be leaving his post soon and won't be around to help bring it to fruition.
Here is the solution for homeowners: get off the grid by storing the solar power your panels collect in your own storage system. True, the needed efficiencies are not quite there yet, but we believe power storage will be the golden ticket for investors in this industry, and the nightmare for utility companies. In the energy storage space, Tesla's (TSLA $900) systems are hard to beat. We also like Johnson Controls (JCI $76), Enphase Energy, and Generac (GNRC $346). To take advantage of the industry without placing a big bet on any one player, the Invesco Solar ETF (TAN $74) may be the way to go. The ETF holds an eclectic group of 49 companies engaged in solar power production, storage, and infrastructure.
Semiconductors & Related Equipment
08. Our Micron position spikes nearly double digits on strong earnings report
We added leading US semiconductor and component maker Micron Technology (MU $90) to the Penn New Frontier Fund just under two months ago at $69.35, with an initial price target of $90. It didn't take long to reach that mark: shares of MU spiked nearly double digits on the morning following a stellar quarterly earnings report. Revenues rose 33% from a year ago, to $7.69 billion, while net income rose from $803 million in the fiscal first quarter of last year to $2.31 billion in the same quarter of this year. The company reported that revenue from dynamic random access memory chips, or DRAM, was up 38% from last year. DRAM chips, which provide low-cost and high-capacity memory, accounted for 73% of total revenue in the quarter; these are the critical chips which will power devices in the world of 5G and the Internet of Things. Chief Business Officer Sumit Sadana was highly bullish on Micron's future in the metaverse, which he said should provide the company with a "tremendous potential demand" going forward. Founded in 1978, Micron employs 43,000 workers and is headquartered in Boise, Idaho.
While it reached our target price much quicker than we expected, we are not considering trimming our position. With the global chip shortage, unprecedented demand on the horizon, and a domestic manufacturing capability, we expect Micron to be a shining star in the portfolio going forward.
Media & Entertainment
07. "Spider-Man: No Way Home" just had a blockbuster weekend; now, who will take home the profits?
When the dust settled, it was the second-largest opening weekend for a movie in cinematic history: "Spider-Man: Now Way Home" brought in $260 million in North American ticket sales alone, placing it behind only "Avengers: Endgame" in the record books. Globally, the news was equally good, with the film grossing $601 million in ticket sales around the world. Industry experts are now expecting the film to hit the $1 billion mark by the end of Christmas weekend. As for who gets the profits, recall that Sony (SONY $121) struck a deal with Marvel back in 1998 to buy the rights to the Spider-Man character, over a decade before Disney (DIS $151) paid $4 billion for the Marvel Cinematic Universe. Through a contorted series of moves since that deal, Sony and Disney came to the agreement—at least for this film—that the latter would provide 25% of the financing in return for 25% of the film's profits, in addition to the merchandising rights. To further muddy the waters, Sony has a previous deal with Netflix (NFLX $606) still in effect, meaning "No Way Home"—or any other Spider-Man movie—probably won't be coming to Disney+ until 2023. Nonetheless, both Sony and Disney should be pleased with their respective share of the profits on this third installment of the latest trilogy. And despite the word "trilogy," a fourth "Spider-Man" is already being planned.
Trying to sift through all of the legal wrangling between Sony and Disney over the years is enough to bring on a headache. Sadly, Disney is now being led by a CEO who is not, shall we say, a world-class negotiator. From an investment standpoint, we would rather own Sony, with its 18 P/E. As lovers of all things Disney, we await regime change at the firm.
Application & Systems Software
06. The Street was generally negative on Oracle's $28 billion purchase of Cerner, but we see potential
From a personal perspective, we hate to see another home-grown company get gobbled up by a much bigger competitor, but from an investment standpoint, does Oracle's (ORCL $92) $28.3 billion acquisition of Kansas City-based Cerner Corp (CERN $90) make sense? At first blush, the integration seems to have plenty of potential synergies. Cerner is a leading electronic health records company, operating in an industry—health information systems—which needs a serious dose of technology. We need look no further than our little white vaccination cards to figure that one out. (At least technology would have made it more difficult for Aaron Rodgers to "alter" his medical history.) Oracle is a $245 billion enterprise software company which developed the first commercial SQL-based relational database management system. It would make perfect sense that this pioneering company would want to buy the established leader in an industry with enormous growth potential. Investors may agree with that premise, but they apparently balked at the $95 per share price-tag, which represents a 25% premium to Cerner's recent trading range. In fact, prior to the announcement Cerner shares were trading around the same price they sat at four years ago, in October of 2017, when we sold them from the Global Leaders Club. Larry Ellison, the brilliant co-founder of Oracle and the company's chief technology officer, is clearly excited about the deal, which makes us feel even stronger about the potential for growth. "With this acquisition," Ellison said, "Oracle's corporate mission expands to...providing our overworked medical professionals with a new generation of easier-to-use digital tools...lowering the administrative workload, improving patient privacy and outcomes, and lowering overall health care costs." Noble goals, indeed.
With Oracle off nearly 10% on news of the acquisition, they are worth a look. We would place a fair value of $100 on the shares, but they should easily grow north of that if the company's plans for Cerner pan out. And for the record, we believe they will.
Capital Markets
05. Blackstone continues to collect real estate assets with purchase of Bluerock Group
There may a Flintstones joke somewhere in the headline, "Blackstone to buy Bluerock," but the $93 billion alternative asset manager has been on a serious mission to increase its real estate holdings recently, and few understand valuations better than Steve Schwarzman and his team. The company's latest acquisition involves a $3.6 billion deal to buy apartment REIT Bluerock Residential Growth, which owns some 30 multifamily rental communities with 11,000 units throughout the Sun Belt—hot growth areas such as Austin, Orlando, and Phoenix. It should be noted that Bluerock also has a portfolio of single-family rentals, which it will spin off to shareholders in the form of the Bluerock Homes Trust. In addition to this deal, Blackstone has already made three other buys thus far in 2021, all in areas we love going forward: industrial REIT WPT, data center REIT QTS Realty Trust, and a collection of student housing properties. Blackstone is one of the world's largest alternative asset managers, with $730 billion in assets under management, including $530 billion in fee-earning assets. The company has a reasonable P/E ratio of 18, and a nice yield of 2.89%—or 100 basis points higher than the current 30-year US Treasury yield.
The sale of Blackstone from the Strategic Income Portfolio several years ago turned out to be one of our most frustrating moves. We liquidated the position due to its status as a limited partnership, meaning it generated K-1s that clients often shy away from. Within months of our selling the position, Blackstone announced that it was converting from a partnership to a corporation. Perhaps we should have re-purchased at that time, but we didn't. At $130, BX shares seem fairly valued, and we expect them to hold up relatively well in what we predict will be a very choppy 2022.
Pharmaceuticals
04. Huge news in the fight against the pandemic: FDA clears two at-home Covid treatments
First it was Pfizer's (PFE $59) Paxlovid, then it was Merck's (MRK $76) molnupiravir, developed in partnership with Ridgeback Biotherapeutics. In the same week, the FDA gave us the news we have been waiting for: two at-home, anti-Covid therapies have been given emergency use authorization for use by Americans who have tested positive for the disease. In clinical trials, Pfizer's Paxlovid reduced the risk of Covid-related hospitalization or death by an impressive 89% if taken within the first three days of symptoms appearing; that percentage is reduced just one point—to 88%—if taken within the first five days. Despite lackluster results on Merck's antiviral treatment, which has been show to reduce hospitalizations and deaths by 30%, the FDA narrowly granted authorization to that treatment as well. Pfizer's treatment consists of three pills twice daily for five days (30 pills), while Merck's therapy consists of four pills twice daily for five days (40 pills). In a related story, France has cancelled a pre-order it had in for Merck's drug based on the disappointing trial results. While it will take time to ramp up production of Pfizer's Paxlovid, the Biden administration has already placed an order for ten million courses of the treatment.
Pfizer is a member of the Penn Global Leaders Club and one of our strongest-conviction stocks for 2022.
Global GDP & Debt
03. The world's $94 trillion economy, in one stunning graphic
Few things paint the story like a good visual, and this stunning graphic from Visual Capitalist proves that point. Here, in one snapshot, is a breakdown of which countries are most responsible for the world's production of goods and offering of services. Note that, despite the fact that we are several years beyond the forecast date (from the press) of China's economy surpassing that of America's, the United States still enjoys an economy that is one-third larger than its second-place rival. Pretty amazing, considering that virtually every item we pick up in the store has "Made in China" stamped somewhere on the packaging. In fact, the US accounts for nearly one-quarter of the world's GDP. While the US dominates the North American, China, to a lesser degree, dominates Asia. There are a number of factors we find of interest in the red section. Note how small India's GDP appears in relation to that of China's, despite the fact that both countries have approximately equal natural resources and populations (1.3 billion Indians vs 1.4 billion Chinese). It was just eleven years ago, in 2010, that China's economic might surpassed Japan's, despite the fact that the latter has a much smaller land mass and one-tenth the population of the former. China claims it controls the nation in the lower left portion of the red, Taiwan, and its $790 billion economy; it is a matter of time before they make a move on that country, forcing some type of American/global response. In the green section of the graphic, one notes how small Russia's economy looks, despite Putin's saber-rattling. Furthermore, around one-third of Russia's economy is energy based (and 60% of its exports), making it vulnerable to price fluctuations in related commodities such as gas and oil. Germany has the continent's largest economy, at $4.23 trillion, followed closely by the UK, France, and Italy. As geopolitical events occur around the world, it is useful to think back to this visual, as what it represents almost certainly plays the major role in the action taking place.
The world is slowly beginning to wake up to the danger of a Communist China playing such a major role in the world, both economically and militarily (though American military might—and Russian, for that matter—still dwarfs that country's arsenal). China's growth rate is already slowing, and we expect that to continue as the world's companies continue to mitigate country risk by building their factories in other Asian countries. Internal issues are the only reason that the world's largest democracy, India, cannot seem to gain more economic traction, but that is slowly changing. We also expect Latin America to have an expanded economic role in the world over the coming decades.
Market Pulse
02. Six companies which played an outsized role in the headlines this past year
To break the year down by headlines in the business media, six companies dominated the news. It is hard to believe, but the meme stock craze just started back in January of this year when the reddit brigade drove the price of GameStop (GME $152) up from around $20 per share to a stratospheric $483 per share on the 28th of the month. In a coordinated effort to attack the shorts, AMC Entertainment (AMC $29) and several other heavily-shorted names became meme stocks shortly thereafter. The beneficiary of this craze, at least initially, was a new trading platform for the masses: Robinhood (HOOD $19), which went public in late July and attained an $85 share price a week later. The company has since lost three-quarters of its market cap. The crypto craze hit full stride by late spring when the Coinbase (COIN $268) platform went public. Nearly 100 cryptos can be easily traded on the platform, and users can make payments from the app using the coin of their choosing—or the US dollar. Coinbase is in the Penn Intrepid Trading Platform and remains one of our favorite plays going into 2022. Pfizer (PFE $59) has been the corporate hero of the pandemic, providing the world's best vaccine to prevent Covid, and the first approved therapy to treat the disease. Tesla (TSLA $1,067), which is in the Penn New Frontier Fund, has been in the headlines throughout the year for a number of reasons, from Elon Musk's entertaining tweets to the company's remarkable production levels to the fact that it became a $1 trillion company this year—one of only a handful. Meta Platforms, yet another Penn name, has been in the headlines for mostly negative reasons this year (via incessant attacks by elected officials), though investors have largely brushed off these headlines. The company, which changed its name from Facebook in October, is up 25% year-to-date. Finally, we have TikTok. We have nothing to say about TikTok.
Several of these companies will remain solidly in the headlines throughout 2022, but new and unexpected additions will certainly arise. For a number of tech darlings which have yet to turn a profit, many of the headlines will be anything but positive. Investors need to watch their high-beta positions diligently, as volatility will rule the year.
Market Pulse
01. A true Santa Claus began to take shape in the markets this week
After an "uh oh" sort of Monday, it was all "ho ho ho" in the markets this Christmas-shortened trading week. Virtually every asset class other than cryptos gained ground, from stocks to commodities to bond yields. The tech-heavy NASDAQ led the charge this week, finishing up 3.19%; followed by the small-cap Russell 2000 (+3.11%), the S&P 500 (+2.28%), and the Dow (+1.65%). Oil closed the week at $73.76, or 5% higher, while gold regained the $1,800 mark, closing at $1,810. With investors now fully bracing for two to three rate hikes next year, the 10-year Treasury hit a yield of 1.495%, meaning that bond values fell. AGG, the iShares Core Aggregate Bond ETF, was off 0.26%.
A Santa Claus rally happens when stocks climb higher in the final seven trading days of a year plus the first two trading days of the new year. So far, so good.
Under the Radar Investment
International Paper (IP $46)
Have you ever stopped to wonder who makes all of those cardboard boxes being dropped off at your front door each week? Odds are good that they were produced by Tennessee-based International Paper. The company accounts for nearly one-third of all corrugated packaging in North America, though it also has major operations in Brazil, Russia, India, and China. This industry could be considered an oligopoly, as it is dominated by three major players: International Paper, WestRock (WR $43), and Packaging Corp. of America (PKG $131). While we actually find all three companies nice value plays, we especially like the new efficiencies IP has put in place over the past several years, its low multiple (10), and the company's growth potential in emerging markets. We would place a fair value of $65 on the shares, which would bring them back up to their summer levels. Oh, and the 4% dividend could be considered the icing on the cake.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Best stock of 1999...
In some ways, 2021 reminds us of 1999. High-tech companies with a lack of profitability as far as the eye can see, speculative investments which seem impervious to fundamental analysis, new platforms bringing trading to the masses. Looking back to 1999, what would have been the best investment (outside of some goofy answer, like the Puerto Rican Cement Company—a high-flying penny stock back in the day) of that year? Hint: it not only still exists, but we own it within our strategies.
Penn Trading Desk:
Oppenheimer: Coinbase listed as a top stock pick for 2022
Oppenheimer has named Penn strategies member Coinbase (COIN $250) as one of its top picks for 2022. The company cited continued and widespread adoption of digital assets as a form of payment, both by retailers and institutions, as rationale for their rating. Coinbase, which is a member of the Penn Intrepid Trading Platform, is a major cryptocurrency exchange allowing for the purchase of hundreds of different cryptocurrencies, as well as the ability to make transactions with these currencies directly from the platform's digital wallet. Oppenheimer has an Outperform rating on the company with a price target of $444 on COIN shares—or 77% higher from here.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecommunication Services
10. US recommends approval of a massive Meta/Google undersea cable project in Asia; China is not amused
The Biden administration has recommended that the FCC grant Meta (FB $334) and Alphabet (GOOG $2,856) licenses to build a 12,000-kilometer-long (7,500 miles) network of undersea fiber optic cables spanning a number of Asian countries—sans China. The effort, known as Project Apricot, will connect Singapore, Japan, Guam, the Philippines, Taiwan, and Indonesia in an effort to bring reliable, high-speed Internet access to portions of the world both underserved and over-reliant on Communist China for their connectivity. The Apricot project will compliment Project Echo, connecting the US with Singapore, Guam, and Indonesia. The ultimate goal, according to Google VP of Global Networking Bikash Koley, is to create multiple (digital) paths in and out of Asia, and "increased resilience in connectivity between Southeast Asia, North Asia, and the United States." A previous joint project to build an undersea cable connecting California and Hong Kong was scrapped by Google and Meta—upon a US Department of Justice recommendation—due to US/Sino tensions. Technology, coupled with gutsy leadership, is making it harder for repressive regimes to constrict the free flow of information, thus controlling the narrative. Needless to say, Beijing is not happy with this project, which is slated to be completed by 2023.
The more China is backed into a corner, the more evident it will become to the free world precisely what the CCP's long-term goals are, and how incompatible they are with the pursuit of human freedom. The West may have a short memory, but we can count on China's ruling communist elites to keep stoking the fire. In the end, freedom always wins.
Renewables
09. Solar stocks are getting crushed on the back of new California proposals
Interesting, coming from the state which claims to be on the vanguard of societal evolution (smirk). The once-darling solar stocks, names like Sunrun (RUN $32), First Solar (FSLR $86), EnPhase Energy (ENPH $180), and SolarEdge Technologies (SEDG $263), have been plummeting since California proposed new rules which would make it more costly for families to put solar panels on their roofs. At the heart of the issue are the California utilities, which don't like the competition from the bourgeois middle class of the state who dare to generate their own household power. These utility concerns, working through the California Public Utilities Commission, wish to extort a monthly "grid fee" from anyone with the panels on their roofs, and they want to reduce the amount of payout for the power coming back to the grid from solar sources. While these recommendations must still be codified by state legislators, the threat was enough to sink the shares of major players. California-based Sunrun, for example, has seen its share price drop by two-thirds since January. One hopeful sign: the commissioner who penned the proposal will be leaving his post soon and won't be around to help bring it to fruition.
Here is the solution for homeowners: get off the grid by storing the solar power your panels collect in your own storage system. True, the needed efficiencies are not quite there yet, but we believe power storage will be the golden ticket for investors in this industry, and the nightmare for utility companies. In the energy storage space, Tesla's (TSLA $900) systems are hard to beat. We also like Johnson Controls (JCI $76), Enphase Energy, and Generac (GNRC $346). To take advantage of the industry without placing a big bet on any one player, the Invesco Solar ETF (TAN $74) may be the way to go. The ETF holds an eclectic group of 49 companies engaged in solar power production, storage, and infrastructure.
Semiconductors & Related Equipment
08. Our Micron position spikes nearly double digits on strong earnings report
We added leading US semiconductor and component maker Micron Technology (MU $90) to the Penn New Frontier Fund just under two months ago at $69.35, with an initial price target of $90. It didn't take long to reach that mark: shares of MU spiked nearly double digits on the morning following a stellar quarterly earnings report. Revenues rose 33% from a year ago, to $7.69 billion, while net income rose from $803 million in the fiscal first quarter of last year to $2.31 billion in the same quarter of this year. The company reported that revenue from dynamic random access memory chips, or DRAM, was up 38% from last year. DRAM chips, which provide low-cost and high-capacity memory, accounted for 73% of total revenue in the quarter; these are the critical chips which will power devices in the world of 5G and the Internet of Things. Chief Business Officer Sumit Sadana was highly bullish on Micron's future in the metaverse, which he said should provide the company with a "tremendous potential demand" going forward. Founded in 1978, Micron employs 43,000 workers and is headquartered in Boise, Idaho.
While it reached our target price much quicker than we expected, we are not considering trimming our position. With the global chip shortage, unprecedented demand on the horizon, and a domestic manufacturing capability, we expect Micron to be a shining star in the portfolio going forward.
Media & Entertainment
07. "Spider-Man: No Way Home" just had a blockbuster weekend; now, who will take home the profits?
When the dust settled, it was the second-largest opening weekend for a movie in cinematic history: "Spider-Man: Now Way Home" brought in $260 million in North American ticket sales alone, placing it behind only "Avengers: Endgame" in the record books. Globally, the news was equally good, with the film grossing $601 million in ticket sales around the world. Industry experts are now expecting the film to hit the $1 billion mark by the end of Christmas weekend. As for who gets the profits, recall that Sony (SONY $121) struck a deal with Marvel back in 1998 to buy the rights to the Spider-Man character, over a decade before Disney (DIS $151) paid $4 billion for the Marvel Cinematic Universe. Through a contorted series of moves since that deal, Sony and Disney came to the agreement—at least for this film—that the latter would provide 25% of the financing in return for 25% of the film's profits, in addition to the merchandising rights. To further muddy the waters, Sony has a previous deal with Netflix (NFLX $606) still in effect, meaning "No Way Home"—or any other Spider-Man movie—probably won't be coming to Disney+ until 2023. Nonetheless, both Sony and Disney should be pleased with their respective share of the profits on this third installment of the latest trilogy. And despite the word "trilogy," a fourth "Spider-Man" is already being planned.
Trying to sift through all of the legal wrangling between Sony and Disney over the years is enough to bring on a headache. Sadly, Disney is now being led by a CEO who is not, shall we say, a world-class negotiator. From an investment standpoint, we would rather own Sony, with its 18 P/E. As lovers of all things Disney, we await regime change at the firm.
Application & Systems Software
06. The Street was generally negative on Oracle's $28 billion purchase of Cerner, but we see potential
From a personal perspective, we hate to see another home-grown company get gobbled up by a much bigger competitor, but from an investment standpoint, does Oracle's (ORCL $92) $28.3 billion acquisition of Kansas City-based Cerner Corp (CERN $90) make sense? At first blush, the integration seems to have plenty of potential synergies. Cerner is a leading electronic health records company, operating in an industry—health information systems—which needs a serious dose of technology. We need look no further than our little white vaccination cards to figure that one out. (At least technology would have made it more difficult for Aaron Rodgers to "alter" his medical history.) Oracle is a $245 billion enterprise software company which developed the first commercial SQL-based relational database management system. It would make perfect sense that this pioneering company would want to buy the established leader in an industry with enormous growth potential. Investors may agree with that premise, but they apparently balked at the $95 per share price-tag, which represents a 25% premium to Cerner's recent trading range. In fact, prior to the announcement Cerner shares were trading around the same price they sat at four years ago, in October of 2017, when we sold them from the Global Leaders Club. Larry Ellison, the brilliant co-founder of Oracle and the company's chief technology officer, is clearly excited about the deal, which makes us feel even stronger about the potential for growth. "With this acquisition," Ellison said, "Oracle's corporate mission expands to...providing our overworked medical professionals with a new generation of easier-to-use digital tools...lowering the administrative workload, improving patient privacy and outcomes, and lowering overall health care costs." Noble goals, indeed.
With Oracle off nearly 10% on news of the acquisition, they are worth a look. We would place a fair value of $100 on the shares, but they should easily grow north of that if the company's plans for Cerner pan out. And for the record, we believe they will.
Capital Markets
05. Blackstone continues to collect real estate assets with purchase of Bluerock Group
There may a Flintstones joke somewhere in the headline, "Blackstone to buy Bluerock," but the $93 billion alternative asset manager has been on a serious mission to increase its real estate holdings recently, and few understand valuations better than Steve Schwarzman and his team. The company's latest acquisition involves a $3.6 billion deal to buy apartment REIT Bluerock Residential Growth, which owns some 30 multifamily rental communities with 11,000 units throughout the Sun Belt—hot growth areas such as Austin, Orlando, and Phoenix. It should be noted that Bluerock also has a portfolio of single-family rentals, which it will spin off to shareholders in the form of the Bluerock Homes Trust. In addition to this deal, Blackstone has already made three other buys thus far in 2021, all in areas we love going forward: industrial REIT WPT, data center REIT QTS Realty Trust, and a collection of student housing properties. Blackstone is one of the world's largest alternative asset managers, with $730 billion in assets under management, including $530 billion in fee-earning assets. The company has a reasonable P/E ratio of 18, and a nice yield of 2.89%—or 100 basis points higher than the current 30-year US Treasury yield.
The sale of Blackstone from the Strategic Income Portfolio several years ago turned out to be one of our most frustrating moves. We liquidated the position due to its status as a limited partnership, meaning it generated K-1s that clients often shy away from. Within months of our selling the position, Blackstone announced that it was converting from a partnership to a corporation. Perhaps we should have re-purchased at that time, but we didn't. At $130, BX shares seem fairly valued, and we expect them to hold up relatively well in what we predict will be a very choppy 2022.
Pharmaceuticals
04. Huge news in the fight against the pandemic: FDA clears two at-home Covid treatments
First it was Pfizer's (PFE $59) Paxlovid, then it was Merck's (MRK $76) molnupiravir, developed in partnership with Ridgeback Biotherapeutics. In the same week, the FDA gave us the news we have been waiting for: two at-home, anti-Covid therapies have been given emergency use authorization for use by Americans who have tested positive for the disease. In clinical trials, Pfizer's Paxlovid reduced the risk of Covid-related hospitalization or death by an impressive 89% if taken within the first three days of symptoms appearing; that percentage is reduced just one point—to 88%—if taken within the first five days. Despite lackluster results on Merck's antiviral treatment, which has been show to reduce hospitalizations and deaths by 30%, the FDA narrowly granted authorization to that treatment as well. Pfizer's treatment consists of three pills twice daily for five days (30 pills), while Merck's therapy consists of four pills twice daily for five days (40 pills). In a related story, France has cancelled a pre-order it had in for Merck's drug based on the disappointing trial results. While it will take time to ramp up production of Pfizer's Paxlovid, the Biden administration has already placed an order for ten million courses of the treatment.
Pfizer is a member of the Penn Global Leaders Club and one of our strongest-conviction stocks for 2022.
Global GDP & Debt
03. The world's $94 trillion economy, in one stunning graphic
Few things paint the story like a good visual, and this stunning graphic from Visual Capitalist proves that point. Here, in one snapshot, is a breakdown of which countries are most responsible for the world's production of goods and offering of services. Note that, despite the fact that we are several years beyond the forecast date (from the press) of China's economy surpassing that of America's, the United States still enjoys an economy that is one-third larger than its second-place rival. Pretty amazing, considering that virtually every item we pick up in the store has "Made in China" stamped somewhere on the packaging. In fact, the US accounts for nearly one-quarter of the world's GDP. While the US dominates the North American, China, to a lesser degree, dominates Asia. There are a number of factors we find of interest in the red section. Note how small India's GDP appears in relation to that of China's, despite the fact that both countries have approximately equal natural resources and populations (1.3 billion Indians vs 1.4 billion Chinese). It was just eleven years ago, in 2010, that China's economic might surpassed Japan's, despite the fact that the latter has a much smaller land mass and one-tenth the population of the former. China claims it controls the nation in the lower left portion of the red, Taiwan, and its $790 billion economy; it is a matter of time before they make a move on that country, forcing some type of American/global response. In the green section of the graphic, one notes how small Russia's economy looks, despite Putin's saber-rattling. Furthermore, around one-third of Russia's economy is energy based (and 60% of its exports), making it vulnerable to price fluctuations in related commodities such as gas and oil. Germany has the continent's largest economy, at $4.23 trillion, followed closely by the UK, France, and Italy. As geopolitical events occur around the world, it is useful to think back to this visual, as what it represents almost certainly plays the major role in the action taking place.
The world is slowly beginning to wake up to the danger of a Communist China playing such a major role in the world, both economically and militarily (though American military might—and Russian, for that matter—still dwarfs that country's arsenal). China's growth rate is already slowing, and we expect that to continue as the world's companies continue to mitigate country risk by building their factories in other Asian countries. Internal issues are the only reason that the world's largest democracy, India, cannot seem to gain more economic traction, but that is slowly changing. We also expect Latin America to have an expanded economic role in the world over the coming decades.
Market Pulse
02. Six companies which played an outsized role in the headlines this past year
To break the year down by headlines in the business media, six companies dominated the news. It is hard to believe, but the meme stock craze just started back in January of this year when the reddit brigade drove the price of GameStop (GME $152) up from around $20 per share to a stratospheric $483 per share on the 28th of the month. In a coordinated effort to attack the shorts, AMC Entertainment (AMC $29) and several other heavily-shorted names became meme stocks shortly thereafter. The beneficiary of this craze, at least initially, was a new trading platform for the masses: Robinhood (HOOD $19), which went public in late July and attained an $85 share price a week later. The company has since lost three-quarters of its market cap. The crypto craze hit full stride by late spring when the Coinbase (COIN $268) platform went public. Nearly 100 cryptos can be easily traded on the platform, and users can make payments from the app using the coin of their choosing—or the US dollar. Coinbase is in the Penn Intrepid Trading Platform and remains one of our favorite plays going into 2022. Pfizer (PFE $59) has been the corporate hero of the pandemic, providing the world's best vaccine to prevent Covid, and the first approved therapy to treat the disease. Tesla (TSLA $1,067), which is in the Penn New Frontier Fund, has been in the headlines throughout the year for a number of reasons, from Elon Musk's entertaining tweets to the company's remarkable production levels to the fact that it became a $1 trillion company this year—one of only a handful. Meta Platforms, yet another Penn name, has been in the headlines for mostly negative reasons this year (via incessant attacks by elected officials), though investors have largely brushed off these headlines. The company, which changed its name from Facebook in October, is up 25% year-to-date. Finally, we have TikTok. We have nothing to say about TikTok.
Several of these companies will remain solidly in the headlines throughout 2022, but new and unexpected additions will certainly arise. For a number of tech darlings which have yet to turn a profit, many of the headlines will be anything but positive. Investors need to watch their high-beta positions diligently, as volatility will rule the year.
Market Pulse
01. A true Santa Claus began to take shape in the markets this week
After an "uh oh" sort of Monday, it was all "ho ho ho" in the markets this Christmas-shortened trading week. Virtually every asset class other than cryptos gained ground, from stocks to commodities to bond yields. The tech-heavy NASDAQ led the charge this week, finishing up 3.19%; followed by the small-cap Russell 2000 (+3.11%), the S&P 500 (+2.28%), and the Dow (+1.65%). Oil closed the week at $73.76, or 5% higher, while gold regained the $1,800 mark, closing at $1,810. With investors now fully bracing for two to three rate hikes next year, the 10-year Treasury hit a yield of 1.495%, meaning that bond values fell. AGG, the iShares Core Aggregate Bond ETF, was off 0.26%.
A Santa Claus rally happens when stocks climb higher in the final seven trading days of a year plus the first two trading days of the new year. So far, so good.
Under the Radar Investment
International Paper (IP $46)
Have you ever stopped to wonder who makes all of those cardboard boxes being dropped off at your front door each week? Odds are good that they were produced by Tennessee-based International Paper. The company accounts for nearly one-third of all corrugated packaging in North America, though it also has major operations in Brazil, Russia, India, and China. This industry could be considered an oligopoly, as it is dominated by three major players: International Paper, WestRock (WR $43), and Packaging Corp. of America (PKG $131). While we actually find all three companies nice value plays, we especially like the new efficiencies IP has put in place over the past several years, its low multiple (10), and the company's growth potential in emerging markets. We would place a fair value of $65 on the shares, which would bring them back up to their summer levels. Oh, and the 4% dividend could be considered the icing on the cake.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Headlines for the Week of 05 Dec — 11 Dec 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Talk about paying for yourself many times over...
On Christmas Day, the Staples Center in Los Angeles, which was built in 1999, will become the Crypto.com Arena. Twenty-two years old may seem "seasoned," but it can't hold a candle to another arena in the country. What is the oldest sports stadium/arena still in use in the United States, and when was it established?
Penn Trading Desk:
Penn: Open Canadian cannabis player in the Intrepid
We believe that one Canadian cannabis firm is well poised to be the industry leader in the US once the drug is legalized at the federal level. Exemplary management, a just-announced acquisition which we love, and a discounted price (to our fair value) led to our decision to add the mid-cap growth company to the Intrepid Trading Platform. Our first price target is 50% above current price, while our second target is nearly double current price.
Penn: Open airline in the Global Leaders Club
Having written glowingly about one particular airline in a recent issue of The Penn Wealth Report, it is only fitting that we would pick it up as one of the 40 positions within the Penn Global Leaders Club, especially after the Omicron scare drove shares down near a 52-week low. Our initial price target is 57% above our purchase price, but we expect to own this forward-looking company well beyond its shares hitting our first target.
Penn: Open fintech giant in Global Leaders Club
Using some contorted logic (proving that efficient market hypothesis is bunk), investors have decided to place a dynamic fintech company in the "old financials" category. The Street's disinterest—or sheer disdain—has driven the price down on this excellent credit services company to the golden ticket range. Additionally, we have been actively searching for strong financial services firms at a reasonable price now that we are overweighting the sector. To see this latest addition to the Penn Global Leaders Club, which carries just 40 members, sign into the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. Come watch the Lakers play at the...Crypto.com Arena?
The meteoric rise of the nascent cryptocurrency market, already $2 trillion in size, has been remarkable. With each passing day, fewer experts seem willing to write the movement off as some sort of fad which will eventually implode. The latest evidence of which comes from California, where the crypto world is about to get some serious signage: Effective Christmas Day, the Staples Center will be renamed Crypto.com Arena. The marketing coup comes at a steep price for the privately-held company. We recall naming rights for stadiums in the $3 million per year price range, which always seemed a bit steep to us. Crypto.com will reportedly pay $700 million for a 20-year contract, which equates to $35 million per year. If those numbers are correct, this would be the second-largest naming rights deal in history, behind 2017's Scotiabank Arena deal in Toronto, which was valued at $800 million for 20 years. Keeping it closer to home, Staples paid $116 million for the previous 20-year deal with The Anschutz Entertainment Group, owner of the arena which has carried its name since 1999. Crypto.com is a low-cost cryptocurrency exchange, much like publicly-traded Coinbase Global (COIN $255), a member of the Penn Intrepid Trading Platform.
Yes, cryptocurrencies are here to stay, but it can be very difficult to separate the long-term winners from the inevitable multitude of losers. We purchased shares in the Coinbase exchange in June at $230 per share—well off of their $429.54 near-IPO price and below their current trading range. We can see why the Coinbase wallet is so attractive to crypto traders, and believe in the company's fundamental story. Our biggest concern about privately-held Crypto.com, despite the pretty cool Matt Damon advertisements, is country risk: it is headquartered in Hong Kong, which is now under the full control of the Communist Party of China.
Consumer Staples
09. Penn member Dollar General announces plans to open 1,000 new Popshelf stores to attract a wealthier clientele
We added Dollar General (DG $222) to the Penn Global Leaders Club—the home for holdings we expect to own for years—when shares of the discount retailer were discount priced themselves, at $71.06. It has been a relatively straight trajectory up from there: shares of the $51 billion Tennessee-based retailer are now trading north of $220. With more than 18,000 stores across the United States, the company's bread-and-butter customer base has been households with annual incomes of 40,000 or less, and we consider the investment an excellent defensive play for any economic downturn. Now, Dollar General has an interesting plan to widen its total addressable market. The company has been testing a concept store called Popshelf which is designed to attract a younger, wealthier group of shoppers. The roughly 9,000 square foot stores have been so popular that management has announced an aggressive plan to open 1,000 Popshelf locations by the end of fiscal 2025. Targeting suburban women with household incomes of between $50,000 and $125,000, the stores will present a bright and lively image, with the mix of goods changing frequently to create a "treasure hunt" vibe. Shoppers searching for unique gifts, holiday decorations, or party supplies should be able to find what they are looking for, all at a reasonable price. We applaud the move, and look forward to checking out one of the new locations. For the first time in its 80-year history, Dollar General also announced it would be delving into the international market, opening ten stores in Mexico by the end of FY 2022.
Despite our success in the position, Dollar General continues to be an overlooked gem by so many retail analysts. That is simply a mistake on their part. For all of its tremendous growth within the Club, it carries a tiny price-to-earnings ratio of seven and an enviable financial position. While others chase multiples that don't exist (because they won't turn a profit for years—if ever), give us an income-generating machine like DG any day.
Multiline Retail
08. Our favorite retailer, Target, gives an early Christmas gift to both customers and employees
Retail juggernaut Target (TGT $248), whose shares have risen 295% in value since we added it as a Consumer Defensive play within the Penn Global Leaders Club under three years ago, has faced two catalysts over the past week which have sent shares lower. Ironically, we love both of them. The first came in the statement following last Wednesday's earnings release. Masterful CEO Brian Cornell, such a different leader than the hapless Gregg Steinhafel, said that the $120 billion retailer was in a "strong inventory position heading into the peak of the holiday season...." Investors were fine with that statement, but when Cornell warned of higher expenses and trimmed gross margins due to inflation and supply constraints, and asserted that Target could "tolerate lower margins if it meant keeping prices (lower for consumers)," which would be fine with him, that was simply too much. A retailer putting customers above fatter margins when those costs could quite easily be passed along? That simply did not compute for investors, which sent the shares down 4% in the pre-market, despite healthy year-on-year revenue and earnings growth. The second share drop within a week came after the company announced that not only was it going to be closed this Thanksgiving, it will remain closed on the holiday in future years as well. What century does Cornell think he is living in? That shaved another 4% or so off of the share price. Two excellent decisions met with derision. That sounds about right.
Some days we watch and listen to an endless stream of malleable, weak, milquetoast CEOs as they contort themselves into odd shapes to prove how enlightened they are. And other days we come in and see something refreshing: true leadership. Cornell's skill at the helm is a major reason why Target remains a shining star in the Penn Global Leaders Club.
Global Strategy: Middle East
07. "Insanity" is how Erdogan's demanded rate cuts in the face of 20% Turkish inflation is being described
To set the stage: Turkey is not a US ally, despite that country's longstanding NATO membership. Under the mercurial leadership of President Recep Tayyip Erdogan, Russia seems to have more influence than does the West, despite Turkey's desire to be seen as part of the EU rather than the Middle East. Under that backdrop comes the bizarre economic situation going on in the country of 85 million people. The main reason that the central bank in the US will probably raise rates at least twice next year is to dampen the rate of inflation, which is currently well above the 2% target range. In Turkey, inflation is running at a nightmarish (for consumers) pace of 20%, so what does Erdogan do? He orders the country's central bank to lower rates. Hence the claims of insanity. And for anyone who believes that the president didn't order the cuts consider this: he has fired three central bank chiefs in the past two years for daring to question his monetary views. Erdogan's defense is that he is waging "an economic war of independence." His strange war has had quite the impact on the Turkish lira, which is now trading at 13:1 versus the US dollar. So, for the unfortunate Turkish worker, this means that their paycheck is being watered down on a daily basis while prices at the local bazar or supermarket are simultaneously going up on a daily basis. A recipe for disaster. Somehow, despite the economic nightmare, Erdogan has still managed to finance the expensive purchase of a Russian-made S-400 missile defense system—a system designed to thwart the most advanced US fighters. To counter the move, the US has removed Turkey from the F-35 joint strike fighter program at a cost of half a billion dollars. The only good news about the economic situation Erdogan is causing within his country is that he will be forced to play defense, taking time away from his mental musings on how to foment more trouble in the region.
It is going to take an uprising by the Turkish people to remove Recep Tayyip Erdogan from power. Despite the fact that his second five-year term, which will end in 2023, should make him ineligible for running again, any bets on who will still be the Turkish president in 2024 and beyond? While that country's constitution prohibits a third term, when has a legal document ever stopped a dictator? Look no further than Vlad Putin. As for a Turkish uprising, sadly, look no further than Venezuela for evidence that those odds, despite the human suffering, are slim to none.
Economics: Work & Pay
06. Trying to dissect the Rorschach test that was the November jobs report
It is always difficult to gauge how investors will react to any given monthly jobs release: a positive report often results in a market downturn, while a lousy one can be a catalyst for gains. Go figure. Even by those standards, November's results and subsequent investor response was a bit strange. Immediately after the release of the jobs survey, which showed a paltry 210,000 new jobs being created in the country against expectations for gains of 550,000, futures rose. This was based on the assumption that the Fed would back off of their threat to end their bond buying program quicker than the current reduction of $15 billion per month. Within the details of the report, however, came some good news: the labor force participation rate—the percentage of Americans of working age either already employed or looking for work—rose to 61.80%, which is the highest level since pre-pandemic. That equates to 600,000 or so Americans re-entering the workforce. Buttressing that point was the household survey section of the report showing that payrolls actually rose by 1.1 million in November. Why the discrepancy? The headline figure represents employers reporting how many hires they had in the month, while the household survey includes individuals moving to self-employed status. In other words, a record number of Americans just started working for themselves. This would also explain why the unemployment rate fell more than expected, to 4.2%. The internals were enough to bring back investors' fear of the Fed tightening quicker than expected to help quell inflation, leading to a 500-point intra-day swing in the Dow. But the Dow's reversal was nothing compared to the NASDAQ and Russell 2000 small-cap index, with each benchmark losing around 2% on the day. It was one of those odd weeks where everything fell in tandem: stocks, bonds, gold, cryptos, and the 10-year Treasury all ended the week in the red.
Following a negative third quarter of the year, a down November for the markets, and a rough start to December, we revisited our January 1st prediction for the year-end S&P 500: 4,300. That would have represented a healthy 14.5% gain on the year. On the Friday of the jobs report, the S&P 500 closed at 4,538, or 238 points above our projection for the year. Granted, anything can happen in any given market week, but we are still looking at a quite strong 2021. The big question for next year will be how investors digest the end of tapering and two to three probable rate hikes.
Interactive Media & Services
05. A visual of the world's largest social media networks and who owns them
Thanks to Visual Capitalist for providing this rather stunning graphic of who actually dominates the explosive world of social media. Shortly before they changed their name to Meta (FB $317), we added shares of $900 billion Facebook back into the Penn Global Leaders Club after a hiatus. Looking beyond the ceaseless attacks by politicians on both sides of the aisle, we believe this company's embrace of the metaverse will lead to a long-term growth trajectory beyond the scope of most analysts' imagination. From a social media usage standpoint, nobody comes close: Meta companies (Facebook, Instagram, WhatsApp, and Messenger) have an aggregate 7.5 billion monthly active users (MAUs), which equates to advertising pricing power miles ahead of the competition. (To be clear, if one person uses all four platforms, as we do, they would be counted four times; still, those numbers are remarkable.) From an individual platform standpoint, Alphabet's (GOOG $2,882) YouTube comes in second to Facebook, with 2.3 billion MAUs. We already own the third largest controlling company on the list, Microsoft (MSFT $326; Skype, LinkedIn, Teams), which continues to be one of our highest conviction names. Skipping over Snap (SNAP $48), which we have never been fond of from an investment standpoint, we come to Twitter (TWTR $45) and its 463M MAUs. Now that Dorsey is gone, we are actually considering picking up some shares of TWTR for the Intrepid Trading Platform. We believe the promotion of Chief Technology Officer Parag Agrawal to the CEO role makes sense for a company which hasn't been able to effectively monetize its business model. Then again, we also thought it made sense for JC Penney to hire Ron Johnson—the guy who created the Apple store model—as CEO, so it is always prudent to wait for evidence of leadership abilities before jumping in. As for the red balls on the list, the Asian names, we wouldn't touch any of them.
At the risk of being labeled a metaverse fanatic, most truly don't understand how the two-dimensional world of social media will morph over the coming years into something truly interactive. Facebook is proven it is all in, which is why it is our number one play in the interactive media and services space.
Application & Systems Software
04. DocuSign shares plunged over 40% in a day; are they a screaming buy right now?
For obvious reasons, shares of DocuSign (DOCU $144), the benchmark in remote document signing technology, skyrocketed during the pandemic-forced lockdown, climbing from $90 in February of last year to $314.76 per share by summer. After a billings miss and a guide-down in the latest quarter, however, the company is now valued at less than half of what is was last year. So, at $144, should investors buy into the story? Although DocuSign has yet to turn a profit, and competing products such as Adobe Sign are gaining traction, the company still posted an impressive revenue growth rate of 50% last quarter. Subscriptions, which give the company a recurring income stream, rose 44% year over year, and over one million customers are now using the e-Signature suite of products. With mass adoption of electronic signatures in virtually every industry, from financial services to health care to government agencies, we tend to agree with management's assessment of a $50 billion total addressable market (TAM), meaning there is still enormous growth potential ahead. Will DocuSign continue to be the company eating away at most of that TAM? Despite so many throwing in the towel after the latest earnings report, we believe they will.
While we do not currently own DocuSign in any of the Penn Portfolios (we do own competitor Adobe in the Global Leaders Club), we do believe the shares will rise back to the $250 range before long. That would signify a 70% jump from the current share price.
Textiles, Apparel, & Luxury Goods
03. Allbirds was overpriced from the start, which is one reason its shares have been slashed in half
We are constantly scanning the IPO calendar, looking for under-the-radar names that won't be devoured by investors at the initial open, driving prices to outrageous levels. Allbirds (BIRD $16) seemed like it had potential; after all, who would get too excited about an athletic footwear maker going public? After pricing 20 million shares at $15 apiece the night before the big debut, we decided to buy in if they fell to the $10-$12 range after trading began. Instead, retail investors gobbled BIRD shares up right out of the gate, driving the price up to an intraday high of $32.44 on the third of November. So much for that trade. One month later, on the 3rd of December, shares had dropped to $13.91 intraday—a 57% course correction. So, are we entertaining the trade once again? Not really. Allbirds shoes are pretty cool, and sales continue to be strong despite the fact they don't believe in discounting the price. The company's self-proclaimed raison d'être is to bring the world eco-friendly and environmentally-sourced shoes. It is hard to go a paragraph deep into any of their ads or press releases without reading the word "sustainability." While management's efforts in this area may be commendable, their words might carry more weight if such a large percentage of Allbirds products weren't made in China—not exactly the ESG capital of the world. In the company's first earnings report since going public, sales came in at $63 million for the quarter funneling down to a net loss of $14 million. For comparison's sake, in its latest quarter $1.1 billion footwear retailer Designer Brands (DBI $16) notched sales of $817 million and had a positive net income of $43 million. Despite its current "discount" from highs, Allbirds seems ripe for another turn downward in the next general market correction.
IPO days for companies we are interested in can be stressful. Trading volatility is high, and the stock price can literally double on the first tick out of the gate. Patience is paramount; if you are priced out (based on your mental buy price) immediately, be patient, as you will have another chance to buy in at a lower price. Even with companies such as Facebook and Tesla, this has always been the case. Use the emotions of others to create wealth in the markets rather than letting your own cloud your judgment.
Pharmaceuticals
02. Pfizer lab studies show third dose of vaccine (the booster) effectively neutralizes the omicron variant of disease
Futures went from negative to positive on Wednesday after pharma giant Pfizer (PFE $51) announced that its lab studies have shown a third dose of the company's Covid-19 vaccine, otherwise known as the booster shot, effectively neutralizes the highly-transmissible omicron strain of the disease. Uncertainty about and fear over the strain helped wreak havoc on markets over the prior two weeks. Researchers at the New Jersey-based firm observed a massive drop in effectiveness of just two doses of the vaccine against this latest strain, yet those who received the booster showed a restored level of protection. Nonetheless, Pfizer continues work on an omicron-targeted shot which may be ready as soon as early spring. More good news: it now appears that the current variant spreading throughout the world, despite its rate of transmission, is less virulent than prior strains, meaning fewer deaths and hospitalizations. On the heels of the Pfizer test results, Cantor Fitzgerald reiterated its Overweight rating on the company and $61 price target on the shares, noting that "...Pfizer's vaccine sales for Covid-19 remain underappreciated by the Street." We couldn't agree more.
Presently, there are some real bargains in the pharmaceutical and biotech space. It is as though investors believe that the entire industry rests on what happens next with respect to Covid-19. Meanwhile, the pipeline of therapies being developed for other life-threatening diseases and maladies has never been deeper. IBB, a cap-weighted ETF of biotech companies, is down 1% on the year, while XBI, an equal-weighted basket of 188 biotechs (and our preferred vehicle in the space) is down over 17% year-to-date. That smells like opportunity.
Economics: Supply, Demand, & Prices
01. The highest inflation rate in forty years didn't dampen the markets
We expected the CPI numbers for November to be bad, and they were. Hitting a rate not seen since 1982, the US Department of Labor announced that the consumer price index (CPI), which measures what consumers pay for a wide swath of goods and services, rose 6.8% annualized in November—the sixth-straight month in which the inflation rate was above 5%. For reference, the Fed's inflation target sits at 2%, and we all recall how "stubbornly low," to use Powell's own words, it was not that long ago. Even stripping food and energy out of the mix, the rate still climbed to 4.9%. What is leading the inflationary charge? Homes are up nearly 20% year-on-year, new vehicles 11%, used vehicles 27%, and fast food prices 8%—just to give a few examples. Unfortunately, while wages have climbed, they are not matching the jump in the price of goods. The Atlanta Fed reported that wage growth was 4.3% in November, annualized.
Oddly enough, the markets largely ignored Friday's CPI release, with the three major indexes (the small caps did not participate) gaining ground on the day. For the week, even the beaten-down Russell 2000 pulled out a gain of 0.76%. Meanwhile, the S&P 500, the DJIA, and the NASDAQ all reclaimed ground not seen since before the prior two week market downturn. We have three weeks left in the month, but December is suddenly looking like it might bring its usual dose of holiday cheer to investors. Of course, next week's Fed meeting could throw a monkey wrench into the works: Fed Chair Powell is highly expected to speed up the rate of taper, perhaps from $15 billion per month to $30 billion per month, which would end the bond buying program by March. Stay tuned.
With the taper now expected to end by next March, economists are raising their expectations for rate hikes next year. The general consensus is one hike by early summer, and two beyond that in 2022. Where will it end? When the target Fed funds rate gets to 2% to 2.5% (the upper band is at 0.25% now), we expect the Fed to halt. Of course, anything can happen between now and that point in time.
Under the Radar Investment
Zimmer Biomet Holdings (ZBH $124)
Zimmer Biomet designs, manufactures, and markets orthopedic reconstructive implants, as well as needed supplies and surgical equipment for orthopedic surgery. The hands-down leader in the field, not only in the United States, but also in Europe and Japan, Zimmer owns some 4,500 patents and applications worldwide. With a highly motivated salesforce and under the strong leadership of CEO Bryan Hanson, we believe the company will continue to solidify its benchmark position. Over the trailing twelve months, Zimmer had sales of $7.9 billion and a net profit of $819 million. We believe the shares of this recession-resistant company are worth $200, or 61% more than their current trading price.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Talk about paying for yourself many times over...
On Christmas Day, the Staples Center in Los Angeles, which was built in 1999, will become the Crypto.com Arena. Twenty-two years old may seem "seasoned," but it can't hold a candle to another arena in the country. What is the oldest sports stadium/arena still in use in the United States, and when was it established?
Penn Trading Desk:
Penn: Open Canadian cannabis player in the Intrepid
We believe that one Canadian cannabis firm is well poised to be the industry leader in the US once the drug is legalized at the federal level. Exemplary management, a just-announced acquisition which we love, and a discounted price (to our fair value) led to our decision to add the mid-cap growth company to the Intrepid Trading Platform. Our first price target is 50% above current price, while our second target is nearly double current price.
Penn: Open airline in the Global Leaders Club
Having written glowingly about one particular airline in a recent issue of The Penn Wealth Report, it is only fitting that we would pick it up as one of the 40 positions within the Penn Global Leaders Club, especially after the Omicron scare drove shares down near a 52-week low. Our initial price target is 57% above our purchase price, but we expect to own this forward-looking company well beyond its shares hitting our first target.
Penn: Open fintech giant in Global Leaders Club
Using some contorted logic (proving that efficient market hypothesis is bunk), investors have decided to place a dynamic fintech company in the "old financials" category. The Street's disinterest—or sheer disdain—has driven the price down on this excellent credit services company to the golden ticket range. Additionally, we have been actively searching for strong financial services firms at a reasonable price now that we are overweighting the sector. To see this latest addition to the Penn Global Leaders Club, which carries just 40 members, sign into the Penn Trading Desk.
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Cryptocurrencies
10. Come watch the Lakers play at the...Crypto.com Arena?
The meteoric rise of the nascent cryptocurrency market, already $2 trillion in size, has been remarkable. With each passing day, fewer experts seem willing to write the movement off as some sort of fad which will eventually implode. The latest evidence of which comes from California, where the crypto world is about to get some serious signage: Effective Christmas Day, the Staples Center will be renamed Crypto.com Arena. The marketing coup comes at a steep price for the privately-held company. We recall naming rights for stadiums in the $3 million per year price range, which always seemed a bit steep to us. Crypto.com will reportedly pay $700 million for a 20-year contract, which equates to $35 million per year. If those numbers are correct, this would be the second-largest naming rights deal in history, behind 2017's Scotiabank Arena deal in Toronto, which was valued at $800 million for 20 years. Keeping it closer to home, Staples paid $116 million for the previous 20-year deal with The Anschutz Entertainment Group, owner of the arena which has carried its name since 1999. Crypto.com is a low-cost cryptocurrency exchange, much like publicly-traded Coinbase Global (COIN $255), a member of the Penn Intrepid Trading Platform.
Yes, cryptocurrencies are here to stay, but it can be very difficult to separate the long-term winners from the inevitable multitude of losers. We purchased shares in the Coinbase exchange in June at $230 per share—well off of their $429.54 near-IPO price and below their current trading range. We can see why the Coinbase wallet is so attractive to crypto traders, and believe in the company's fundamental story. Our biggest concern about privately-held Crypto.com, despite the pretty cool Matt Damon advertisements, is country risk: it is headquartered in Hong Kong, which is now under the full control of the Communist Party of China.
Consumer Staples
09. Penn member Dollar General announces plans to open 1,000 new Popshelf stores to attract a wealthier clientele
We added Dollar General (DG $222) to the Penn Global Leaders Club—the home for holdings we expect to own for years—when shares of the discount retailer were discount priced themselves, at $71.06. It has been a relatively straight trajectory up from there: shares of the $51 billion Tennessee-based retailer are now trading north of $220. With more than 18,000 stores across the United States, the company's bread-and-butter customer base has been households with annual incomes of 40,000 or less, and we consider the investment an excellent defensive play for any economic downturn. Now, Dollar General has an interesting plan to widen its total addressable market. The company has been testing a concept store called Popshelf which is designed to attract a younger, wealthier group of shoppers. The roughly 9,000 square foot stores have been so popular that management has announced an aggressive plan to open 1,000 Popshelf locations by the end of fiscal 2025. Targeting suburban women with household incomes of between $50,000 and $125,000, the stores will present a bright and lively image, with the mix of goods changing frequently to create a "treasure hunt" vibe. Shoppers searching for unique gifts, holiday decorations, or party supplies should be able to find what they are looking for, all at a reasonable price. We applaud the move, and look forward to checking out one of the new locations. For the first time in its 80-year history, Dollar General also announced it would be delving into the international market, opening ten stores in Mexico by the end of FY 2022.
Despite our success in the position, Dollar General continues to be an overlooked gem by so many retail analysts. That is simply a mistake on their part. For all of its tremendous growth within the Club, it carries a tiny price-to-earnings ratio of seven and an enviable financial position. While others chase multiples that don't exist (because they won't turn a profit for years—if ever), give us an income-generating machine like DG any day.
Multiline Retail
08. Our favorite retailer, Target, gives an early Christmas gift to both customers and employees
Retail juggernaut Target (TGT $248), whose shares have risen 295% in value since we added it as a Consumer Defensive play within the Penn Global Leaders Club under three years ago, has faced two catalysts over the past week which have sent shares lower. Ironically, we love both of them. The first came in the statement following last Wednesday's earnings release. Masterful CEO Brian Cornell, such a different leader than the hapless Gregg Steinhafel, said that the $120 billion retailer was in a "strong inventory position heading into the peak of the holiday season...." Investors were fine with that statement, but when Cornell warned of higher expenses and trimmed gross margins due to inflation and supply constraints, and asserted that Target could "tolerate lower margins if it meant keeping prices (lower for consumers)," which would be fine with him, that was simply too much. A retailer putting customers above fatter margins when those costs could quite easily be passed along? That simply did not compute for investors, which sent the shares down 4% in the pre-market, despite healthy year-on-year revenue and earnings growth. The second share drop within a week came after the company announced that not only was it going to be closed this Thanksgiving, it will remain closed on the holiday in future years as well. What century does Cornell think he is living in? That shaved another 4% or so off of the share price. Two excellent decisions met with derision. That sounds about right.
Some days we watch and listen to an endless stream of malleable, weak, milquetoast CEOs as they contort themselves into odd shapes to prove how enlightened they are. And other days we come in and see something refreshing: true leadership. Cornell's skill at the helm is a major reason why Target remains a shining star in the Penn Global Leaders Club.
Global Strategy: Middle East
07. "Insanity" is how Erdogan's demanded rate cuts in the face of 20% Turkish inflation is being described
To set the stage: Turkey is not a US ally, despite that country's longstanding NATO membership. Under the mercurial leadership of President Recep Tayyip Erdogan, Russia seems to have more influence than does the West, despite Turkey's desire to be seen as part of the EU rather than the Middle East. Under that backdrop comes the bizarre economic situation going on in the country of 85 million people. The main reason that the central bank in the US will probably raise rates at least twice next year is to dampen the rate of inflation, which is currently well above the 2% target range. In Turkey, inflation is running at a nightmarish (for consumers) pace of 20%, so what does Erdogan do? He orders the country's central bank to lower rates. Hence the claims of insanity. And for anyone who believes that the president didn't order the cuts consider this: he has fired three central bank chiefs in the past two years for daring to question his monetary views. Erdogan's defense is that he is waging "an economic war of independence." His strange war has had quite the impact on the Turkish lira, which is now trading at 13:1 versus the US dollar. So, for the unfortunate Turkish worker, this means that their paycheck is being watered down on a daily basis while prices at the local bazar or supermarket are simultaneously going up on a daily basis. A recipe for disaster. Somehow, despite the economic nightmare, Erdogan has still managed to finance the expensive purchase of a Russian-made S-400 missile defense system—a system designed to thwart the most advanced US fighters. To counter the move, the US has removed Turkey from the F-35 joint strike fighter program at a cost of half a billion dollars. The only good news about the economic situation Erdogan is causing within his country is that he will be forced to play defense, taking time away from his mental musings on how to foment more trouble in the region.
It is going to take an uprising by the Turkish people to remove Recep Tayyip Erdogan from power. Despite the fact that his second five-year term, which will end in 2023, should make him ineligible for running again, any bets on who will still be the Turkish president in 2024 and beyond? While that country's constitution prohibits a third term, when has a legal document ever stopped a dictator? Look no further than Vlad Putin. As for a Turkish uprising, sadly, look no further than Venezuela for evidence that those odds, despite the human suffering, are slim to none.
Economics: Work & Pay
06. Trying to dissect the Rorschach test that was the November jobs report
It is always difficult to gauge how investors will react to any given monthly jobs release: a positive report often results in a market downturn, while a lousy one can be a catalyst for gains. Go figure. Even by those standards, November's results and subsequent investor response was a bit strange. Immediately after the release of the jobs survey, which showed a paltry 210,000 new jobs being created in the country against expectations for gains of 550,000, futures rose. This was based on the assumption that the Fed would back off of their threat to end their bond buying program quicker than the current reduction of $15 billion per month. Within the details of the report, however, came some good news: the labor force participation rate—the percentage of Americans of working age either already employed or looking for work—rose to 61.80%, which is the highest level since pre-pandemic. That equates to 600,000 or so Americans re-entering the workforce. Buttressing that point was the household survey section of the report showing that payrolls actually rose by 1.1 million in November. Why the discrepancy? The headline figure represents employers reporting how many hires they had in the month, while the household survey includes individuals moving to self-employed status. In other words, a record number of Americans just started working for themselves. This would also explain why the unemployment rate fell more than expected, to 4.2%. The internals were enough to bring back investors' fear of the Fed tightening quicker than expected to help quell inflation, leading to a 500-point intra-day swing in the Dow. But the Dow's reversal was nothing compared to the NASDAQ and Russell 2000 small-cap index, with each benchmark losing around 2% on the day. It was one of those odd weeks where everything fell in tandem: stocks, bonds, gold, cryptos, and the 10-year Treasury all ended the week in the red.
Following a negative third quarter of the year, a down November for the markets, and a rough start to December, we revisited our January 1st prediction for the year-end S&P 500: 4,300. That would have represented a healthy 14.5% gain on the year. On the Friday of the jobs report, the S&P 500 closed at 4,538, or 238 points above our projection for the year. Granted, anything can happen in any given market week, but we are still looking at a quite strong 2021. The big question for next year will be how investors digest the end of tapering and two to three probable rate hikes.
Interactive Media & Services
05. A visual of the world's largest social media networks and who owns them
Thanks to Visual Capitalist for providing this rather stunning graphic of who actually dominates the explosive world of social media. Shortly before they changed their name to Meta (FB $317), we added shares of $900 billion Facebook back into the Penn Global Leaders Club after a hiatus. Looking beyond the ceaseless attacks by politicians on both sides of the aisle, we believe this company's embrace of the metaverse will lead to a long-term growth trajectory beyond the scope of most analysts' imagination. From a social media usage standpoint, nobody comes close: Meta companies (Facebook, Instagram, WhatsApp, and Messenger) have an aggregate 7.5 billion monthly active users (MAUs), which equates to advertising pricing power miles ahead of the competition. (To be clear, if one person uses all four platforms, as we do, they would be counted four times; still, those numbers are remarkable.) From an individual platform standpoint, Alphabet's (GOOG $2,882) YouTube comes in second to Facebook, with 2.3 billion MAUs. We already own the third largest controlling company on the list, Microsoft (MSFT $326; Skype, LinkedIn, Teams), which continues to be one of our highest conviction names. Skipping over Snap (SNAP $48), which we have never been fond of from an investment standpoint, we come to Twitter (TWTR $45) and its 463M MAUs. Now that Dorsey is gone, we are actually considering picking up some shares of TWTR for the Intrepid Trading Platform. We believe the promotion of Chief Technology Officer Parag Agrawal to the CEO role makes sense for a company which hasn't been able to effectively monetize its business model. Then again, we also thought it made sense for JC Penney to hire Ron Johnson—the guy who created the Apple store model—as CEO, so it is always prudent to wait for evidence of leadership abilities before jumping in. As for the red balls on the list, the Asian names, we wouldn't touch any of them.
At the risk of being labeled a metaverse fanatic, most truly don't understand how the two-dimensional world of social media will morph over the coming years into something truly interactive. Facebook is proven it is all in, which is why it is our number one play in the interactive media and services space.
Application & Systems Software
04. DocuSign shares plunged over 40% in a day; are they a screaming buy right now?
For obvious reasons, shares of DocuSign (DOCU $144), the benchmark in remote document signing technology, skyrocketed during the pandemic-forced lockdown, climbing from $90 in February of last year to $314.76 per share by summer. After a billings miss and a guide-down in the latest quarter, however, the company is now valued at less than half of what is was last year. So, at $144, should investors buy into the story? Although DocuSign has yet to turn a profit, and competing products such as Adobe Sign are gaining traction, the company still posted an impressive revenue growth rate of 50% last quarter. Subscriptions, which give the company a recurring income stream, rose 44% year over year, and over one million customers are now using the e-Signature suite of products. With mass adoption of electronic signatures in virtually every industry, from financial services to health care to government agencies, we tend to agree with management's assessment of a $50 billion total addressable market (TAM), meaning there is still enormous growth potential ahead. Will DocuSign continue to be the company eating away at most of that TAM? Despite so many throwing in the towel after the latest earnings report, we believe they will.
While we do not currently own DocuSign in any of the Penn Portfolios (we do own competitor Adobe in the Global Leaders Club), we do believe the shares will rise back to the $250 range before long. That would signify a 70% jump from the current share price.
Textiles, Apparel, & Luxury Goods
03. Allbirds was overpriced from the start, which is one reason its shares have been slashed in half
We are constantly scanning the IPO calendar, looking for under-the-radar names that won't be devoured by investors at the initial open, driving prices to outrageous levels. Allbirds (BIRD $16) seemed like it had potential; after all, who would get too excited about an athletic footwear maker going public? After pricing 20 million shares at $15 apiece the night before the big debut, we decided to buy in if they fell to the $10-$12 range after trading began. Instead, retail investors gobbled BIRD shares up right out of the gate, driving the price up to an intraday high of $32.44 on the third of November. So much for that trade. One month later, on the 3rd of December, shares had dropped to $13.91 intraday—a 57% course correction. So, are we entertaining the trade once again? Not really. Allbirds shoes are pretty cool, and sales continue to be strong despite the fact they don't believe in discounting the price. The company's self-proclaimed raison d'être is to bring the world eco-friendly and environmentally-sourced shoes. It is hard to go a paragraph deep into any of their ads or press releases without reading the word "sustainability." While management's efforts in this area may be commendable, their words might carry more weight if such a large percentage of Allbirds products weren't made in China—not exactly the ESG capital of the world. In the company's first earnings report since going public, sales came in at $63 million for the quarter funneling down to a net loss of $14 million. For comparison's sake, in its latest quarter $1.1 billion footwear retailer Designer Brands (DBI $16) notched sales of $817 million and had a positive net income of $43 million. Despite its current "discount" from highs, Allbirds seems ripe for another turn downward in the next general market correction.
IPO days for companies we are interested in can be stressful. Trading volatility is high, and the stock price can literally double on the first tick out of the gate. Patience is paramount; if you are priced out (based on your mental buy price) immediately, be patient, as you will have another chance to buy in at a lower price. Even with companies such as Facebook and Tesla, this has always been the case. Use the emotions of others to create wealth in the markets rather than letting your own cloud your judgment.
Pharmaceuticals
02. Pfizer lab studies show third dose of vaccine (the booster) effectively neutralizes the omicron variant of disease
Futures went from negative to positive on Wednesday after pharma giant Pfizer (PFE $51) announced that its lab studies have shown a third dose of the company's Covid-19 vaccine, otherwise known as the booster shot, effectively neutralizes the highly-transmissible omicron strain of the disease. Uncertainty about and fear over the strain helped wreak havoc on markets over the prior two weeks. Researchers at the New Jersey-based firm observed a massive drop in effectiveness of just two doses of the vaccine against this latest strain, yet those who received the booster showed a restored level of protection. Nonetheless, Pfizer continues work on an omicron-targeted shot which may be ready as soon as early spring. More good news: it now appears that the current variant spreading throughout the world, despite its rate of transmission, is less virulent than prior strains, meaning fewer deaths and hospitalizations. On the heels of the Pfizer test results, Cantor Fitzgerald reiterated its Overweight rating on the company and $61 price target on the shares, noting that "...Pfizer's vaccine sales for Covid-19 remain underappreciated by the Street." We couldn't agree more.
Presently, there are some real bargains in the pharmaceutical and biotech space. It is as though investors believe that the entire industry rests on what happens next with respect to Covid-19. Meanwhile, the pipeline of therapies being developed for other life-threatening diseases and maladies has never been deeper. IBB, a cap-weighted ETF of biotech companies, is down 1% on the year, while XBI, an equal-weighted basket of 188 biotechs (and our preferred vehicle in the space) is down over 17% year-to-date. That smells like opportunity.
Economics: Supply, Demand, & Prices
01. The highest inflation rate in forty years didn't dampen the markets
We expected the CPI numbers for November to be bad, and they were. Hitting a rate not seen since 1982, the US Department of Labor announced that the consumer price index (CPI), which measures what consumers pay for a wide swath of goods and services, rose 6.8% annualized in November—the sixth-straight month in which the inflation rate was above 5%. For reference, the Fed's inflation target sits at 2%, and we all recall how "stubbornly low," to use Powell's own words, it was not that long ago. Even stripping food and energy out of the mix, the rate still climbed to 4.9%. What is leading the inflationary charge? Homes are up nearly 20% year-on-year, new vehicles 11%, used vehicles 27%, and fast food prices 8%—just to give a few examples. Unfortunately, while wages have climbed, they are not matching the jump in the price of goods. The Atlanta Fed reported that wage growth was 4.3% in November, annualized.
Oddly enough, the markets largely ignored Friday's CPI release, with the three major indexes (the small caps did not participate) gaining ground on the day. For the week, even the beaten-down Russell 2000 pulled out a gain of 0.76%. Meanwhile, the S&P 500, the DJIA, and the NASDAQ all reclaimed ground not seen since before the prior two week market downturn. We have three weeks left in the month, but December is suddenly looking like it might bring its usual dose of holiday cheer to investors. Of course, next week's Fed meeting could throw a monkey wrench into the works: Fed Chair Powell is highly expected to speed up the rate of taper, perhaps from $15 billion per month to $30 billion per month, which would end the bond buying program by March. Stay tuned.
With the taper now expected to end by next March, economists are raising their expectations for rate hikes next year. The general consensus is one hike by early summer, and two beyond that in 2022. Where will it end? When the target Fed funds rate gets to 2% to 2.5% (the upper band is at 0.25% now), we expect the Fed to halt. Of course, anything can happen between now and that point in time.
Under the Radar Investment
Zimmer Biomet Holdings (ZBH $124)
Zimmer Biomet designs, manufactures, and markets orthopedic reconstructive implants, as well as needed supplies and surgical equipment for orthopedic surgery. The hands-down leader in the field, not only in the United States, but also in Europe and Japan, Zimmer owns some 4,500 patents and applications worldwide. With a highly motivated salesforce and under the strong leadership of CEO Bryan Hanson, we believe the company will continue to solidify its benchmark position. Over the trailing twelve months, Zimmer had sales of $7.9 billion and a net profit of $819 million. We believe the shares of this recession-resistant company are worth $200, or 61% more than their current trading price.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Headlines for the Week of 07 Nov — 13 Nov 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The last time inflation was this hot...
With inflation at its highest level since December of 1990, let's take a trip down memory lane. What was the top-grossing movie in that month, 31 years ago? Hint: It had somewhat of a Christmas-related theme.
Penn Trading Desk:
Penn: Close American Campus Communities in the Strategic Income Portfolio
In the summer of 2020, rumors of kids not returning to dorm rooms in fall began circulating throughout the financial press. These concerns hammered our favorite student housing REIT, American Campus Communities (ACC $54). We never bought into the hype, and added ACC to the Strategic Income Portfolio (it had a dividend around 5%) at $34.43 per share. Now, with shares sitting near their 52-week high and carrying a lofty valuation, we took our 57% profit off the table. We still believe in the company, but the shares seem a bit rich to us at this level. Additionally, we are building our cash position.
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Leisure Equipment, Products, & Facilities
10. If you were upset that you missed Peloton's massive share price run-up, you have been given a second chance
We added exercise equipment company Peloton (PTON $50) to the Intrepid Trading Platform way back in February of 2020 (which seems like a lifetime ago) at $29.11 per share. While we had a nice gain in the position, we certainly missed the majority of the run-up as it rocketed all the way to $167.42 in the early days of the pandemic. The company makes the best-selling treads and stationary bikes on the market, but we have had misgivings about its rather mandatory subscription service—it costs $39 per month and the hardware/software interface makes it difficult to do without. As could be expected, the return to some semblance of normalcy has led to a resurgence in gym memberships and a slew of lowered price targets for this "stay-at-home" play. The company has also dealt with recalls following the well-publicized safety issues of its pricey Tread+ and an ongoing battle with the Consumer Product Safety Commission. The company's problems hit a crescendo last week when Peloton's management team lowered full-year guidance and reported a net loss of $376 million for the latest quarter. With most analysts slashing their price targets nearly in half, and the shares falling 70% from their intraday highs of 14 Jan 2021, is the damage done or does this portend more pain ahead? That will depend on how management responds to its three imminent threats: increased competition in the space, safety issues, and a consumer base ready to get back out into the world.
As we write this, PTON shares have fallen to the $50 range. The company, for all of its challenges, is not going anywhere, and we believe it will effectively deal with its issues. It should be noted that the company sells a large percentage of its equipment to health clubs, universities, and hotels—though it doesn't give investors a breakout of its commercial sales. Additionally, Peloton just completed its $$420 million acquisition of Precor, an exercise equipment manufacturer which primarily sells to commercial entities such as hotel chains, picking up 625,000 square feet of manufacturing space in the process. While we don't currently own PTON in any Penn strategy, $50 seems like a tempting buy point.
Fintech
09. PayPal's Venmo unit strikes deal with Amazon to become a payment option at checkout; we remain bullish
Just last month we were talking about PayPal's (PYPL $229) supposed $40 billion acquisition of Pinterest (PINS $47). While the company quickly quelled those rumors, we do believe they were actually interested in buying the social media platform. Feeling the heat from competitors such as Square (SQ $237), which recently paid $29 billion for buy now-pay later firm Afterpay, the company desperately wants to expand its fintech offerings. While that transaction never happened, the company's Venmo unit did just notch a big victory: it inked a deal with online behemoth Amazon (AMZN $3,489) to become a checkout option for customers at Amazon.com. Considering Amazon is responsible for over 40% of online purchases, that is a pretty big deal. PayPal made the announcement during its mixed-quarter earnings report. While revenues in Q3 rose from $5.46 billion to $6.18 billion year-on-year, that 13% increase fell slightly below analyst expectations. Profits, however, did beat expectations of $1.07/share, with net revenue actually jumping to $1.11/share. Shares were little changed after hours following the earnings report and the announcement. PayPal was spun off from eBay six years ago and has 377 million active accounts, including 29 million merchant accounts.
For some reason, PayPal has been portrayed by many as "old school" fintech. That is simply inaccurate. It is a $270 billion fintech giant, and the leader in the secure online payment space. While we were sorry to see the Pinterest deal fail to manifest, management is not done searching for a good fit. CEO Dan Schulman will not sit idly by while new upstarts eat into his company's market share. We place a fair value on PYPL shares at $300, but investors may want to see if continued Wall Street pessimism pushes them down to the $200 range before considering a purchase.
Industrial Conglomerates
08. Following 1-8 reverse split, GE now says it will split into three firms
Just three months ago, storied industrial giant General Electric (GE $116) performed a 1-8 reverse split, making its shares magically go from $13 to $105 in an instant. Now, GE's management team has announced another split: the company itself will be divided into three parts. The GE name will live on in the new aviation company, while the healthcare and energy units will become separate entities. All of these moves, however, won't allow the disparate companies to escape from the aggregate debt racked up by years of mismanagement; debt which could not be erased by the continual fire-sale of units, such as the 2016 sale of GE Appliances to Chinese conglomerate Haier for $5.6 billion, or the sale of GE lighting to Savant Systems in 2020 for an undisclosed amount. At least Savant is manufacturing the light bulbs in the US (as evidenced by an old package of GE bulbs which reads, "Made in China," versus a newer package we found which reads, "Made in USA"). While the spinoff of the healthcare unit won't take place until the end of 2023, and the energy spinoff won't happen until the end of 2024, investors cheered the move by driving GE shares up 6% in the pre-market following the announcement. CEO Larry Culp told Barron's, "It is a wow sort of day." That is about the response we would have expected. At least we didn't have to listen to Jeffrey Immelt bloviating some long-winded response from the cabin of one of his two personal corporate jets.
What would we do if we still held GE shares in any of the Penn strategies? Take the spike in price as an opportunity to exit the position. We certainly wouldn't wait around three years for the completion of the spinoffs. As for GE, with Culp running one company, perhaps the board should invite the other two post-Jack Welch CEOs—Immelt and Flannery—to take the respective helm of the other firms.
Hotels, Resorts, & Cruise Lines
07. Airbnb prepares for "golden age of travel" with new tools built around the hybrid work environment
We fully planned to add shares of Airbnb (ABNB $195) to one of the Penn strategies on its long-anticipated IPO day. Alas, it shot out of the gate so quickly that we could not justify the rich valuation. The company has inarguably changed the travel landscape, with its platform boasting some 5.6 million active accommodation listings worldwide. While the major hotel chains have effectively fought back to avoid losing market share, and a number of competitors have since tried to replicate their business model, we remain bullish on the company's long-term strategy. To that end, the $124 billion travel/tech firm has announced the rollout of some 50 new features designed to take advantage of the new, post-covid world; a world in which remote work is no longer the exception, and a large percentage of travel has morphed into a business/leisure affair. The company is placing a greater focus on its customers who book long-term stays of four weeks or longer, as that is now its fastest-growing segment. The suite of new tools will include the ability to verify wi-fi speeds to assure an effective work environment, and a listings search which will now go out a year into the future. For hosts, Airbnb is rolling out AirCover, an insurance program which offers $1 million in both damage protection and liability coverage, as well as "deep-cleaning" protection. As for the company's third-quarter earnings, they were off the charts. Revenues came in at $2.24 billion versus $1.34 billion in the same quarter of 2020 (+67%), and profits rose 280% y/y for the quarter, to $834 million. The company gave bullish guidance for Q4, with expectations that the rosy projections will carry into 2022.
Morningstar places the fair value of ABNB shares at $102. While we don't buy into that valuation, a price floating around $200 per share is still too rich for us. Looking elsewhere in the industry, our favorite hotel chain—Hilton Worldwide (HLT)—also seems richly priced at $147 per share (1,200 P/E). Ditto online travel agency Booking Holdings (BKNG $2,641), with its 288 multiple. Our advice? Wait for the inevitable pullback in these travel names.
Economics: Supply, Demand, & Prices
06. Inflation on the price of consumer goods just came in scorchingly hot; is it a blip or cause for serious concern?
Anyone who fills their tank, shops for groceries, pays their rent, or—gulp—needs a new or used car knows that inflation is a reality. Forget the anecdotal stories, here is the data: the US Department of Labor just announced that consumer prices surged 0.9% from September to October, driving the y/y rate up to 6.2%. That marks the highest rate since December of 1990, and the fastest pace of inflation since the summer of 1982. The rate even exceeded the 5.4% spike economists had projected. As for the ten million missing workers in the US, expect the price of goods to drive them back to their well-paying jobs soon. Serious supply chain issues certainly play a major role in the price spike, but the upward pressure on wages is another major factor; industries across all sectors are being forced to pay their workers more. While the supply chain issues should begin to subside by early next year, the higher wages are probably here to stay, which is good news in itself, but tempered by the fact that inflation is eating away at those wages. Management teams have been echoing the same sentiment: price increases must be passed along to the consumer, and the pricing power is in place to allow those increases without facing much pushback. In other words, Americans seem willing to pay more for lumber, autos, travel, and Christmas gifts this year. The Fed has already implemented its plan to reduce bond buying by $15 billion per month until it hits zero, and telegraphed plans to begin raising interest rates by late next year. If inflation reports keep coming in hot, however, they may need to quicken their pace. And that is a specter investors may not be prepared to handle with aplomb.
Products such as gasoline may be inelastic, but we believe inflation across the board will cause shoppers to become more sensitive to higher prices on easily-substituted goods and services. And the online shopping genie is out of the bottle, meaning consumers can perform their due diligence with ease. While the days of the Fed worrying about sub-2% inflation may be gone, the fears of long-lasting and severe price jumps have been overblown. This is not the 1970s all over again. From an investment standpoint, we have increased our allocation to the financial sector, which will be one of the areas poised to gain by higher interest rates.
Automotive
05. Making sense of Elon Musk's tweet asking followers whether or not he should sell 10% of his Tesla shares
Last Saturday, Elon Musk posed the following question to his 63.3 million Twitter followers: "Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock. Do you support this?" In a roughly 60/40 split, with 3.5 million voters (including us, we voted in the affirmative), the answer was "yes." While we wouldn't label the tweet as a gimmick, as many business journalists have, it is true that Musk really has no choice but to sell a good portion of his shares. Due to Tesla's achievement of some remarkably high targets, Musk has around 23 million vested stock options from 2012 with a strike price of roughly $6 per share. These options will expire next year, so he must exercise them and take the ordinary income (not realized gain) tax hit on the difference between $6 and the share price when he sells. Considering the shares are currently trading around $1,082, that tax bill we be enormous. In fact, it will probably be the largest single tax bill paid by an individual in history. (Though we doubt he will get a thank you card from the IRS or any politicians on the Hill.) Tesla also hit challenging targets which gave Musk options to purchase another 101 million shares at around $70 per share. These were issued in 2018, and represent about 5% of all outstanding shares.
In trading action this week, Musk sold approximately 5 million of his Tesla shares, grossing him around $5 billion. Between the federal government and the state of California, and between ordinary income tax and capital gains, about 54% of that amount will disappear in the form of taxes. Musk, who has never taken a salary from Tesla, once famously quipped to his brother Kimbal, who had asked him for a loan, "You do know that I don't actually have any cash, right? I have to borrow." While his trades this week will certainly put some cash in his pocket, we fully expect him to make good on his promise to live by the results of the twitter poll; if for no other reason than to pay the $7 billion or so the IRS will soon come calling for due to his remaining options. Even after all of the sales are complete, Musk will still own around 15% of outstanding TSLA shares, or more than double the amount of the next largest shareholder, Vanguard Group. Last month, Elon Musk became the first person in the world to achieve a net worth in excess of $300 billion, eclipsing that of the second-place Jeff Bezos, who is worth around $200 billion.
Even at $1,085 per share, we still consider Tesla, which we own in the Penn New Frontier Fund, a buy. All of the critics who argue that Ford, GM, Volkswagen, and a slew of startups will end up dooming the company seem to assume that Tesla will simply stand still. As usual, they will be proven grossly wrong. We would place the current fair value of TSLA shares at $1,800.
Media & Entertainment
04. Disney shares hit a ten-month low following an unexpectedly-rough quarter
Our lack of confidence in Disney's (DIS $162) new management team has been well articulated. It has been clear in our writings that we have little confidence in the company's new CEO, former parks head Bob Chapek, to lead the American icon going forward. Perhaps we received the first hard evidence of that view via the company's fiscal Q4 earnings report. The company missed on both the top and bottom lines, and it was downhill from there. While revenues grew 26% y/y for the quarter, to $18.5 billion, analysts were expecting more, especially considering the park restrictions due to covid in the same quarter of last year. Earnings per share came in a whopping 73% below estimates, at $0.37 adjusted. But the worst news, perhaps, came in the subs figure for the Disney+ streaming service. After adding 12 million new subscribers in the previous quarter, the company added just 2.1 million new subs in fiscal Q4. That is around 9.4 million fewer than analysts were expecting. The average monthly revenue per subscriber (ARPS) for Disney+ also dropped year-on-year, to $4.12, thanks to special bundle pricing for the Indonesia and India markets. Certainly, the return to the office for millions of Americans had an impact on the muted numbers, and park activity will continue to pick up, but investors gave a thumbs-down to the earnings report: Disney shares fell 7% in the following session, hitting a new ten-month low.
Disney was a company we never wanted to remove from the Penn Global Leaders Club; but, like Boeing, General Electric, and McDonald's, concerns over management forced us to make the move. After the big drop, are the shares undervalued? We don't believe so. Perhaps we will take another look if they get down below their 52-week low of $134.
Global Strategy: Eastern Europe
03. The US has warned Europe to be prepared for a potential Russian invasion of Ukraine
Russia's mercurial de facto dictator, Vladimir Putin, doesn't need an excuse to cause problems and wreak havoc, but he currently has two: a migrant issue and a pipeline issue. And, according to the Biden administration, Ukraine might be the battleground. The US has warned its Western allies in Europe that Russia is building up its forces near the Ukrainian border, and some level of military operations in the country—to include a possible invasion, may be in the cards. On the energy front, tensions have been heated between Western Europe and Russia, which provides nearly half of the natural gas to countries such as Germany. (Poland, it should be noted, receives most of its natural gas from the United States, after shunning Russia's Gazprom.) Putin is demanding that European regulators immediately approve the already-built Nord Stream 2 gas pipeline which runs between Russia and Germany. Despite Europe's severe gas crunch and skyrocketing LNG prices, the pipeline is in limbo due to Germany's new left-leaning government which is currently being formed. The US and Ukraine have vehemently opposed the pipeline. On the migrant front, thousands of Belarus refugees have flocked to that Russian ally's border with Poland in an attempt to get into Western Europe. Poland, a staunch US ally, has held firm on the issue, with full backing from the EU. This has enraged the president of Belarus, Alexander Lukashenko, who is now threatening to cut off LNG supples from another pipeline which travels from Russia to the West. All of this comes at a time when energy prices are at multi-year highs, meaning Russia, which has an energy-based economy, is suddenly feeling even more emboldened than usual.
For all of America's challenges, Europe is currently getting hit with crises on all sides of the economic spectrum, from a new wave of the pandemic to the severe energy problems. Granted, many of these challenges are from self-inflicted wounds, but the best course of action they could take right now is to make Putin understand that military action on his western front will not be tolerated. Sadly, the historical record of Europe standing up to bullies is spotty, at best.
Specialty REITs
02. Penn member American Tower to buy data center REIT CoreSite Realty in $10 billion deal
We purchased specialty REIT American Tower Corp (AMT $261), owner and operator of over 185,000 cell towers around the world, back in March of this year. The addition took advantage of two of our favorite themes: real estate and 5G technology. After hitting our initial target price within eight months, the company made a move we fully embrace: it will acquire data center REIT CoreSite Realty for $170 per share in cash—roughly $8.3 billion—plus the assumption of its $2 billion or so of debt. We believe it was a smart move by a skilled management team, led by AMT CEO Tom Bartlett. With the bolt-on acquisition of CoreSite, AMT will add data and cloud management capabilities to its offering mix, fully complimenting its wireless communications business. We suddenly find ourselves with two of our favorite growth drivers in the REIT world—5G towers and data centers—morphed into one position within the Penn Global Leaders Club. Furthermore, the company's reach is truly global, with 75,000 towers in Asia/Pacific, 43,000 in North America, 42,000 in Latin America, 20,000 in Africa, and 5,000 in Europe. For its part, CoreSite operates 24 data centers in major urban hubs such as Boston, New York, Miami, Chicago, and Los Angeles.
AMT shares are down about 4% on the news, as is typical for an acquiring company immediately after a deal has been announced. For investors who have missed the run-up to this point, we believe the shares remain in an attractive buy range. REITs are an important part of a portfolio, but we are highly concerned about the rapidly-changing landscape for retail and office REITs. Data centers and towers, as mentioned, will be two of the strongest growth drivers for the industry going forward.
Food Products
01. Oatly shares just plummeted another 21% in one session, now down 68% from their high
We first wrote about oat milk products company Oatly Group AB (OTLY $9) when the Swedish firm went public back in May. After the IPO priced at $17, shares rose 37% almost immediately. By the 16th of June, they had topped out at an intra-day high of $29 per share. We believed they were overvalued from day one, and reminded investors of the competition in the space. Just because a company appears to be in the stream of a fast moving theme—like plant-based products, they are not automatically good investment candidates. That is a story we have seen in constant reruns for the past 25 years. Alas, reality just hit OTLY shares after the company reported a revenue miss, greater losses than expected, and a warning from management with respect to the full-year's guidance. On top of the dismal financials, it was also reported that a quality issue in one of Oatly's production facilities will result in destroyed product and lost sales in the EMEA (Europe, Middle East, Africa) region. Perhaps the worst news of all: arch-competitor Chobani has officially filed to go public, and Danone, owner of the Silk brand of plant-based "milks," announced it is doubling-down on its "Oat-Yeah" product line. Oatly had a rough summer; it appears that the company is headed for an ugly winter.
When we first wrote of Oatly's debut, we said the shares were overvalued but might be worth a look if they dropped below $20. They are now sitting at $9.36 and still don't seem like a bargain. We can't figure out what the company's unique value proposition is, and even its commitment to the ESG (the most overused acronym in the global corporate environment) movement is being questioned by the environment police. Shares may seem cheap, but we wouldn't touch them.
Under the Radar Investment
Callaway Golf (ELY $29)
Callaway Golf Company is a mid-cap ($5.5B) leisure products firm dedicated to the game of golf. The company's golf equipment segment manufactures golf balls and clubs, while its apparel and gear segment manufactures golf shoes, clothing, bags, and practice aids. Just a few years ago, articles were written of the sport's imminent demise in the United States, and advice was given on how to extend its lifespan by silly actions such as doubling the size of the hole to make the game easier for inexperienced players. What nonsense. As is so often the case, the self-proclaimed experts were dead wrong, and the 270-year-old sport is going through a renaissance in this country—thanks in part to the pandemic. Another reason for the game's resurgence and popularity among a younger demographic base is a company called Topgolf, a global sports entertainment venue headquartered in Dallas, Texas. With seventy locations throughout the world, these tech-driven operations have created a new generation of golf enthusiasts. Imagine morphing a video game, nightclub, and personal sports experience into one, and you get an idea of why the facilities are so popular. This year, Callaway Golf completed its acquisition of Topgolf for $2.6 billion in stock and announced aggressive—but methodical—expansion plans. At $29 per share, Callaway has a near-single-digit multiple, a strong balance sheet, and a viable growth strategy. Not many leisure companies can boast those attributes. We would put a fair value on ELY shares at $40.
Answer
In December of 1990, America was still in the midst of Operation Desert Shield—it wouldn't turn into a "Storm" until the following month. The top grossing film in December was Home Alone, which grossed $90 million throughout 2,173 theaters, followed by Dances with Wolves, Misery, and Kindergarten Cop.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The last time inflation was this hot...
With inflation at its highest level since December of 1990, let's take a trip down memory lane. What was the top-grossing movie in that month, 31 years ago? Hint: It had somewhat of a Christmas-related theme.
Penn Trading Desk:
Penn: Close American Campus Communities in the Strategic Income Portfolio
In the summer of 2020, rumors of kids not returning to dorm rooms in fall began circulating throughout the financial press. These concerns hammered our favorite student housing REIT, American Campus Communities (ACC $54). We never bought into the hype, and added ACC to the Strategic Income Portfolio (it had a dividend around 5%) at $34.43 per share. Now, with shares sitting near their 52-week high and carrying a lofty valuation, we took our 57% profit off the table. We still believe in the company, but the shares seem a bit rich to us at this level. Additionally, we are building our cash position.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Leisure Equipment, Products, & Facilities
10. If you were upset that you missed Peloton's massive share price run-up, you have been given a second chance
We added exercise equipment company Peloton (PTON $50) to the Intrepid Trading Platform way back in February of 2020 (which seems like a lifetime ago) at $29.11 per share. While we had a nice gain in the position, we certainly missed the majority of the run-up as it rocketed all the way to $167.42 in the early days of the pandemic. The company makes the best-selling treads and stationary bikes on the market, but we have had misgivings about its rather mandatory subscription service—it costs $39 per month and the hardware/software interface makes it difficult to do without. As could be expected, the return to some semblance of normalcy has led to a resurgence in gym memberships and a slew of lowered price targets for this "stay-at-home" play. The company has also dealt with recalls following the well-publicized safety issues of its pricey Tread+ and an ongoing battle with the Consumer Product Safety Commission. The company's problems hit a crescendo last week when Peloton's management team lowered full-year guidance and reported a net loss of $376 million for the latest quarter. With most analysts slashing their price targets nearly in half, and the shares falling 70% from their intraday highs of 14 Jan 2021, is the damage done or does this portend more pain ahead? That will depend on how management responds to its three imminent threats: increased competition in the space, safety issues, and a consumer base ready to get back out into the world.
As we write this, PTON shares have fallen to the $50 range. The company, for all of its challenges, is not going anywhere, and we believe it will effectively deal with its issues. It should be noted that the company sells a large percentage of its equipment to health clubs, universities, and hotels—though it doesn't give investors a breakout of its commercial sales. Additionally, Peloton just completed its $$420 million acquisition of Precor, an exercise equipment manufacturer which primarily sells to commercial entities such as hotel chains, picking up 625,000 square feet of manufacturing space in the process. While we don't currently own PTON in any Penn strategy, $50 seems like a tempting buy point.
Fintech
09. PayPal's Venmo unit strikes deal with Amazon to become a payment option at checkout; we remain bullish
Just last month we were talking about PayPal's (PYPL $229) supposed $40 billion acquisition of Pinterest (PINS $47). While the company quickly quelled those rumors, we do believe they were actually interested in buying the social media platform. Feeling the heat from competitors such as Square (SQ $237), which recently paid $29 billion for buy now-pay later firm Afterpay, the company desperately wants to expand its fintech offerings. While that transaction never happened, the company's Venmo unit did just notch a big victory: it inked a deal with online behemoth Amazon (AMZN $3,489) to become a checkout option for customers at Amazon.com. Considering Amazon is responsible for over 40% of online purchases, that is a pretty big deal. PayPal made the announcement during its mixed-quarter earnings report. While revenues in Q3 rose from $5.46 billion to $6.18 billion year-on-year, that 13% increase fell slightly below analyst expectations. Profits, however, did beat expectations of $1.07/share, with net revenue actually jumping to $1.11/share. Shares were little changed after hours following the earnings report and the announcement. PayPal was spun off from eBay six years ago and has 377 million active accounts, including 29 million merchant accounts.
For some reason, PayPal has been portrayed by many as "old school" fintech. That is simply inaccurate. It is a $270 billion fintech giant, and the leader in the secure online payment space. While we were sorry to see the Pinterest deal fail to manifest, management is not done searching for a good fit. CEO Dan Schulman will not sit idly by while new upstarts eat into his company's market share. We place a fair value on PYPL shares at $300, but investors may want to see if continued Wall Street pessimism pushes them down to the $200 range before considering a purchase.
Industrial Conglomerates
08. Following 1-8 reverse split, GE now says it will split into three firms
Just three months ago, storied industrial giant General Electric (GE $116) performed a 1-8 reverse split, making its shares magically go from $13 to $105 in an instant. Now, GE's management team has announced another split: the company itself will be divided into three parts. The GE name will live on in the new aviation company, while the healthcare and energy units will become separate entities. All of these moves, however, won't allow the disparate companies to escape from the aggregate debt racked up by years of mismanagement; debt which could not be erased by the continual fire-sale of units, such as the 2016 sale of GE Appliances to Chinese conglomerate Haier for $5.6 billion, or the sale of GE lighting to Savant Systems in 2020 for an undisclosed amount. At least Savant is manufacturing the light bulbs in the US (as evidenced by an old package of GE bulbs which reads, "Made in China," versus a newer package we found which reads, "Made in USA"). While the spinoff of the healthcare unit won't take place until the end of 2023, and the energy spinoff won't happen until the end of 2024, investors cheered the move by driving GE shares up 6% in the pre-market following the announcement. CEO Larry Culp told Barron's, "It is a wow sort of day." That is about the response we would have expected. At least we didn't have to listen to Jeffrey Immelt bloviating some long-winded response from the cabin of one of his two personal corporate jets.
What would we do if we still held GE shares in any of the Penn strategies? Take the spike in price as an opportunity to exit the position. We certainly wouldn't wait around three years for the completion of the spinoffs. As for GE, with Culp running one company, perhaps the board should invite the other two post-Jack Welch CEOs—Immelt and Flannery—to take the respective helm of the other firms.
Hotels, Resorts, & Cruise Lines
07. Airbnb prepares for "golden age of travel" with new tools built around the hybrid work environment
We fully planned to add shares of Airbnb (ABNB $195) to one of the Penn strategies on its long-anticipated IPO day. Alas, it shot out of the gate so quickly that we could not justify the rich valuation. The company has inarguably changed the travel landscape, with its platform boasting some 5.6 million active accommodation listings worldwide. While the major hotel chains have effectively fought back to avoid losing market share, and a number of competitors have since tried to replicate their business model, we remain bullish on the company's long-term strategy. To that end, the $124 billion travel/tech firm has announced the rollout of some 50 new features designed to take advantage of the new, post-covid world; a world in which remote work is no longer the exception, and a large percentage of travel has morphed into a business/leisure affair. The company is placing a greater focus on its customers who book long-term stays of four weeks or longer, as that is now its fastest-growing segment. The suite of new tools will include the ability to verify wi-fi speeds to assure an effective work environment, and a listings search which will now go out a year into the future. For hosts, Airbnb is rolling out AirCover, an insurance program which offers $1 million in both damage protection and liability coverage, as well as "deep-cleaning" protection. As for the company's third-quarter earnings, they were off the charts. Revenues came in at $2.24 billion versus $1.34 billion in the same quarter of 2020 (+67%), and profits rose 280% y/y for the quarter, to $834 million. The company gave bullish guidance for Q4, with expectations that the rosy projections will carry into 2022.
Morningstar places the fair value of ABNB shares at $102. While we don't buy into that valuation, a price floating around $200 per share is still too rich for us. Looking elsewhere in the industry, our favorite hotel chain—Hilton Worldwide (HLT)—also seems richly priced at $147 per share (1,200 P/E). Ditto online travel agency Booking Holdings (BKNG $2,641), with its 288 multiple. Our advice? Wait for the inevitable pullback in these travel names.
Economics: Supply, Demand, & Prices
06. Inflation on the price of consumer goods just came in scorchingly hot; is it a blip or cause for serious concern?
Anyone who fills their tank, shops for groceries, pays their rent, or—gulp—needs a new or used car knows that inflation is a reality. Forget the anecdotal stories, here is the data: the US Department of Labor just announced that consumer prices surged 0.9% from September to October, driving the y/y rate up to 6.2%. That marks the highest rate since December of 1990, and the fastest pace of inflation since the summer of 1982. The rate even exceeded the 5.4% spike economists had projected. As for the ten million missing workers in the US, expect the price of goods to drive them back to their well-paying jobs soon. Serious supply chain issues certainly play a major role in the price spike, but the upward pressure on wages is another major factor; industries across all sectors are being forced to pay their workers more. While the supply chain issues should begin to subside by early next year, the higher wages are probably here to stay, which is good news in itself, but tempered by the fact that inflation is eating away at those wages. Management teams have been echoing the same sentiment: price increases must be passed along to the consumer, and the pricing power is in place to allow those increases without facing much pushback. In other words, Americans seem willing to pay more for lumber, autos, travel, and Christmas gifts this year. The Fed has already implemented its plan to reduce bond buying by $15 billion per month until it hits zero, and telegraphed plans to begin raising interest rates by late next year. If inflation reports keep coming in hot, however, they may need to quicken their pace. And that is a specter investors may not be prepared to handle with aplomb.
Products such as gasoline may be inelastic, but we believe inflation across the board will cause shoppers to become more sensitive to higher prices on easily-substituted goods and services. And the online shopping genie is out of the bottle, meaning consumers can perform their due diligence with ease. While the days of the Fed worrying about sub-2% inflation may be gone, the fears of long-lasting and severe price jumps have been overblown. This is not the 1970s all over again. From an investment standpoint, we have increased our allocation to the financial sector, which will be one of the areas poised to gain by higher interest rates.
Automotive
05. Making sense of Elon Musk's tweet asking followers whether or not he should sell 10% of his Tesla shares
Last Saturday, Elon Musk posed the following question to his 63.3 million Twitter followers: "Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock. Do you support this?" In a roughly 60/40 split, with 3.5 million voters (including us, we voted in the affirmative), the answer was "yes." While we wouldn't label the tweet as a gimmick, as many business journalists have, it is true that Musk really has no choice but to sell a good portion of his shares. Due to Tesla's achievement of some remarkably high targets, Musk has around 23 million vested stock options from 2012 with a strike price of roughly $6 per share. These options will expire next year, so he must exercise them and take the ordinary income (not realized gain) tax hit on the difference between $6 and the share price when he sells. Considering the shares are currently trading around $1,082, that tax bill we be enormous. In fact, it will probably be the largest single tax bill paid by an individual in history. (Though we doubt he will get a thank you card from the IRS or any politicians on the Hill.) Tesla also hit challenging targets which gave Musk options to purchase another 101 million shares at around $70 per share. These were issued in 2018, and represent about 5% of all outstanding shares.
In trading action this week, Musk sold approximately 5 million of his Tesla shares, grossing him around $5 billion. Between the federal government and the state of California, and between ordinary income tax and capital gains, about 54% of that amount will disappear in the form of taxes. Musk, who has never taken a salary from Tesla, once famously quipped to his brother Kimbal, who had asked him for a loan, "You do know that I don't actually have any cash, right? I have to borrow." While his trades this week will certainly put some cash in his pocket, we fully expect him to make good on his promise to live by the results of the twitter poll; if for no other reason than to pay the $7 billion or so the IRS will soon come calling for due to his remaining options. Even after all of the sales are complete, Musk will still own around 15% of outstanding TSLA shares, or more than double the amount of the next largest shareholder, Vanguard Group. Last month, Elon Musk became the first person in the world to achieve a net worth in excess of $300 billion, eclipsing that of the second-place Jeff Bezos, who is worth around $200 billion.
Even at $1,085 per share, we still consider Tesla, which we own in the Penn New Frontier Fund, a buy. All of the critics who argue that Ford, GM, Volkswagen, and a slew of startups will end up dooming the company seem to assume that Tesla will simply stand still. As usual, they will be proven grossly wrong. We would place the current fair value of TSLA shares at $1,800.
Media & Entertainment
04. Disney shares hit a ten-month low following an unexpectedly-rough quarter
Our lack of confidence in Disney's (DIS $162) new management team has been well articulated. It has been clear in our writings that we have little confidence in the company's new CEO, former parks head Bob Chapek, to lead the American icon going forward. Perhaps we received the first hard evidence of that view via the company's fiscal Q4 earnings report. The company missed on both the top and bottom lines, and it was downhill from there. While revenues grew 26% y/y for the quarter, to $18.5 billion, analysts were expecting more, especially considering the park restrictions due to covid in the same quarter of last year. Earnings per share came in a whopping 73% below estimates, at $0.37 adjusted. But the worst news, perhaps, came in the subs figure for the Disney+ streaming service. After adding 12 million new subscribers in the previous quarter, the company added just 2.1 million new subs in fiscal Q4. That is around 9.4 million fewer than analysts were expecting. The average monthly revenue per subscriber (ARPS) for Disney+ also dropped year-on-year, to $4.12, thanks to special bundle pricing for the Indonesia and India markets. Certainly, the return to the office for millions of Americans had an impact on the muted numbers, and park activity will continue to pick up, but investors gave a thumbs-down to the earnings report: Disney shares fell 7% in the following session, hitting a new ten-month low.
Disney was a company we never wanted to remove from the Penn Global Leaders Club; but, like Boeing, General Electric, and McDonald's, concerns over management forced us to make the move. After the big drop, are the shares undervalued? We don't believe so. Perhaps we will take another look if they get down below their 52-week low of $134.
Global Strategy: Eastern Europe
03. The US has warned Europe to be prepared for a potential Russian invasion of Ukraine
Russia's mercurial de facto dictator, Vladimir Putin, doesn't need an excuse to cause problems and wreak havoc, but he currently has two: a migrant issue and a pipeline issue. And, according to the Biden administration, Ukraine might be the battleground. The US has warned its Western allies in Europe that Russia is building up its forces near the Ukrainian border, and some level of military operations in the country—to include a possible invasion, may be in the cards. On the energy front, tensions have been heated between Western Europe and Russia, which provides nearly half of the natural gas to countries such as Germany. (Poland, it should be noted, receives most of its natural gas from the United States, after shunning Russia's Gazprom.) Putin is demanding that European regulators immediately approve the already-built Nord Stream 2 gas pipeline which runs between Russia and Germany. Despite Europe's severe gas crunch and skyrocketing LNG prices, the pipeline is in limbo due to Germany's new left-leaning government which is currently being formed. The US and Ukraine have vehemently opposed the pipeline. On the migrant front, thousands of Belarus refugees have flocked to that Russian ally's border with Poland in an attempt to get into Western Europe. Poland, a staunch US ally, has held firm on the issue, with full backing from the EU. This has enraged the president of Belarus, Alexander Lukashenko, who is now threatening to cut off LNG supples from another pipeline which travels from Russia to the West. All of this comes at a time when energy prices are at multi-year highs, meaning Russia, which has an energy-based economy, is suddenly feeling even more emboldened than usual.
For all of America's challenges, Europe is currently getting hit with crises on all sides of the economic spectrum, from a new wave of the pandemic to the severe energy problems. Granted, many of these challenges are from self-inflicted wounds, but the best course of action they could take right now is to make Putin understand that military action on his western front will not be tolerated. Sadly, the historical record of Europe standing up to bullies is spotty, at best.
Specialty REITs
02. Penn member American Tower to buy data center REIT CoreSite Realty in $10 billion deal
We purchased specialty REIT American Tower Corp (AMT $261), owner and operator of over 185,000 cell towers around the world, back in March of this year. The addition took advantage of two of our favorite themes: real estate and 5G technology. After hitting our initial target price within eight months, the company made a move we fully embrace: it will acquire data center REIT CoreSite Realty for $170 per share in cash—roughly $8.3 billion—plus the assumption of its $2 billion or so of debt. We believe it was a smart move by a skilled management team, led by AMT CEO Tom Bartlett. With the bolt-on acquisition of CoreSite, AMT will add data and cloud management capabilities to its offering mix, fully complimenting its wireless communications business. We suddenly find ourselves with two of our favorite growth drivers in the REIT world—5G towers and data centers—morphed into one position within the Penn Global Leaders Club. Furthermore, the company's reach is truly global, with 75,000 towers in Asia/Pacific, 43,000 in North America, 42,000 in Latin America, 20,000 in Africa, and 5,000 in Europe. For its part, CoreSite operates 24 data centers in major urban hubs such as Boston, New York, Miami, Chicago, and Los Angeles.
AMT shares are down about 4% on the news, as is typical for an acquiring company immediately after a deal has been announced. For investors who have missed the run-up to this point, we believe the shares remain in an attractive buy range. REITs are an important part of a portfolio, but we are highly concerned about the rapidly-changing landscape for retail and office REITs. Data centers and towers, as mentioned, will be two of the strongest growth drivers for the industry going forward.
Food Products
01. Oatly shares just plummeted another 21% in one session, now down 68% from their high
We first wrote about oat milk products company Oatly Group AB (OTLY $9) when the Swedish firm went public back in May. After the IPO priced at $17, shares rose 37% almost immediately. By the 16th of June, they had topped out at an intra-day high of $29 per share. We believed they were overvalued from day one, and reminded investors of the competition in the space. Just because a company appears to be in the stream of a fast moving theme—like plant-based products, they are not automatically good investment candidates. That is a story we have seen in constant reruns for the past 25 years. Alas, reality just hit OTLY shares after the company reported a revenue miss, greater losses than expected, and a warning from management with respect to the full-year's guidance. On top of the dismal financials, it was also reported that a quality issue in one of Oatly's production facilities will result in destroyed product and lost sales in the EMEA (Europe, Middle East, Africa) region. Perhaps the worst news of all: arch-competitor Chobani has officially filed to go public, and Danone, owner of the Silk brand of plant-based "milks," announced it is doubling-down on its "Oat-Yeah" product line. Oatly had a rough summer; it appears that the company is headed for an ugly winter.
When we first wrote of Oatly's debut, we said the shares were overvalued but might be worth a look if they dropped below $20. They are now sitting at $9.36 and still don't seem like a bargain. We can't figure out what the company's unique value proposition is, and even its commitment to the ESG (the most overused acronym in the global corporate environment) movement is being questioned by the environment police. Shares may seem cheap, but we wouldn't touch them.
Under the Radar Investment
Callaway Golf (ELY $29)
Callaway Golf Company is a mid-cap ($5.5B) leisure products firm dedicated to the game of golf. The company's golf equipment segment manufactures golf balls and clubs, while its apparel and gear segment manufactures golf shoes, clothing, bags, and practice aids. Just a few years ago, articles were written of the sport's imminent demise in the United States, and advice was given on how to extend its lifespan by silly actions such as doubling the size of the hole to make the game easier for inexperienced players. What nonsense. As is so often the case, the self-proclaimed experts were dead wrong, and the 270-year-old sport is going through a renaissance in this country—thanks in part to the pandemic. Another reason for the game's resurgence and popularity among a younger demographic base is a company called Topgolf, a global sports entertainment venue headquartered in Dallas, Texas. With seventy locations throughout the world, these tech-driven operations have created a new generation of golf enthusiasts. Imagine morphing a video game, nightclub, and personal sports experience into one, and you get an idea of why the facilities are so popular. This year, Callaway Golf completed its acquisition of Topgolf for $2.6 billion in stock and announced aggressive—but methodical—expansion plans. At $29 per share, Callaway has a near-single-digit multiple, a strong balance sheet, and a viable growth strategy. Not many leisure companies can boast those attributes. We would put a fair value on ELY shares at $40.
Answer
In December of 1990, America was still in the midst of Operation Desert Shield—it wouldn't turn into a "Storm" until the following month. The top grossing film in December was Home Alone, which grossed $90 million throughout 2,173 theaters, followed by Dances with Wolves, Misery, and Kindergarten Cop.
Headlines for the Week of 31 Oct — 06 Nov 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Purpose-driven spending...
You just purchased a new home and need to select the appliances—refrigerator, washer and dryer, range, dishwasher, microwave—for the joint. You would like to buy products made in North America, Europe, Japan, or South Korea; four regions known for making quality consumer durables. You decide upon the GE Appliances line based on their century-old reputation. Did you meet your objective?
Penn Trading Desk:
Penn: Open educational services company in the Intrepid
We have followed this major American educational services company for the past five years and, while we found it overvalued at recent levels, found it irresistible after lowered guidance and an analyst cut sent shares plummeting. We added this mid-cap growth company to the Intrepid Trading Platform with an initial price target 53% higher than our purchase price, and a secondary price target double our purchase price.
Penn: Open communication services firm in the Global Leaders Club
Oddly enough, we haven't recently held any firms from the Communication Services sector in the Penn Global Leaders Club—a rare condition. We rectified that with a pickup of one of the most controversial companies in America. Here's the way we see it: this behemoth is an income-generating machine, dominates its segment, and has a bold strategic plan for its future. Political correctness be damned, we added this juggernaut to the portfolio with high expectations for future growth.
Penn: Open a US semiconductor powerhouse (not Intel) to the New Frontier Fund
There is a major (and much needed) push underway for increased domestic production of high-tech semiconductor devices and components. We added a US-based manufacturer which will play a major role in the Internet of Things (IoT), 5G, autonomous vehicles, and AI/VR to the New Frontier Fund.
Penn: Open a hammered booze company in the Intrepid
We have watched investors analyze booze companies incorrectly more times than we can count, and our most recent addition to the Penn Intrepid Trading Program is a glaring example. Making a few poor decisions, one on hard seltzer and another on a new beer launch, made investors lose faith; but management matters, and we fully expect this company's exemplary chairman of the board to right his ship.
Penn: Open a regional bank in the Strategic Income Portfolio
Based on the specter of rising rates and not-so-transitory inflation, we have increased our allocation within the Financials sector. To that end, we added a regional bank (Northeastern US) with a clean balance sheet and a hefty dividend yield to our income portfolio. Members, see the Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
eCommerce
10. Netflix is teaming up with Walmart to create a dedicated digital storefront on the retailing giant's website
As Netflix's (NFLX $624) subscriber growth cools, it continues to search for new revenue streams in an effort to become less reliant on the one metric analysts focus on each quarter. To that end, the company has announced a new deal with Walmart (WMT $141) which will result in a dedicated 'Netflix Hub' on the giant retailer's website. The shop will include themed merchandise from its wildly-successful "Squid Game" as well as other recent hits on the streaming service, such as "Stranger Things." Right now, Netflix receives the vast majority of its revenue from the $13.99 paid monthly (more or less, depending on subscription plan) by its 200 million subscribers around the world. The growth of that subscriber base has been leveling out, however, due to saturation and a host of new entrants in the space, from Disney+ to Amazon Prime Video. While CEO Reed Hastings said he doesn't expect the new venture to have a major impact on the company's top line, he believes the real value comes in building user engagement with and excitement for the provider's Netflix Originals, for which it currently spends over $5 billion per year developing. Netflix licenses its intellectual property to select manufacturers in exchange for a cut of the profit. As for Walmart, this deal is part of an overall strategy to increase its online Walmart Marketplace presence by teaming up with brands held in high esteem by consumers. Like the recent deal with Gap, the company hopes to broaden its customer base by attracting a new generation of consumers; primarily younger customers who might have avoided the company's site in the past.
Based on valuations and our current tilt toward more conservative names, we believe Walmart shares look more attractive right now than those of its new marketing partner, Netflix. When another downturn hits the market, we could see NFLX shares falling back into the $400s—at which time they would be worthy of another look.
Communication Services
09. Over the course of twenty years, AT&T shares have dropped 43%; is it time to buy?
Our stop-loss order on AT&T (T $26) shares finally hit this past May at $32, ending a miserable period of holding the once-great telecom company. That stop was fortuitous, as shares have dropped to $26 since we dumped them. At least we had the fat dividend yield (now at 8% based on the share price, though it will be adjusted down after spinoffs), but that is about the only positive aspect of owning the shares since we picked them up. Our super-long-term 26% gain was not worth the wait; the opportunity cost was tremendous. In fact, an investment in the S&P 500 twenty years ago would have given investors just shy of a 500% return, while the same investment in T shares would have lost nearly 50% after two decades, sans the dividend.
Enormous missteps by management—like overpaying for acquisitions they could never quite make fit into the T puzzle, and ignoring serious problems with customer service due to sheer arrogance—have brought us to this point. Other telecom companies have proven that industry flux is not the issue; poor management is the root cause. So, with the shares "dirt cheap," as some analysts have called them, is it time to bet on the storied company? The argument for purchase revolves around the company's plan to slim down and focus its efforts exclusively on telecom services, mainly its 5G wireless network. It already ditched its wildly-expensive DirecTV unit and is about to spinoff its WarnerMedia division, which will become Warner Bros. Discovery. But we have three major arguments against the bull case. First, the company still has a massive debt load of $180 billion, which will only be negligibly alleviated by the Warner spinoff. Second, the company's area of focus going forward is going to be hyper-competitive thanks to new technologies and entrants. Finally, we have about as much faith in the management team at T as we do in the team at Boeing.
It is certainly tempting to pick up shares of T at $26, but we have seen the stock languish for too long to get excited here. It may end up being a multiyear low price, but there are simply too many obstacles facing the lackluster leadership team.
Homes & Durables
08. Zillow falls double digits as it presses pause on its home buying program; competitor Opendoor Technologies jumps*
(UPDATE: Zillow has announced it has exited the home flipping business altogether, sending shares tumbling another 25% on Wednesday. Considering the percentage of revenues generated by the unit, we are even more concerned now than when we wrote this piece on Monday.)
It didn't strike us as a viable reason for the company's shares to fall over 10%, but Zillow's (Z $65) announcement that it would hold off on buying any more homes while it works through a backlog of properties caused the shares to tumble on Monday. Zillow Offers, the company's high-tech buying and flipping unit, purchased nearly 4,000 homes in the second quarter of the year. And the unit is hardly an afterthought: it produced $772 million of the $1.31 billion—or 60%—in total revenue generated over the three-month period. With that in mind, why would management bring buying to a screeching halt? The answer, according to management, revolves around what the company does after purchasing the properties.
One of the biggest headaches for sellers involves evaluating what needs to be repaired or replaced in a home before it is listed. Using its proprietary home value algorithms, Zillow will make homeowners an offer on the spot—no repair or staging required. This means that the company must perform the repairs and prepare the house for sale. While it won't invest in homes with extensive damage or with major needed repairs, COO Jeremy Wacksman told investors that labor and supply constraints have been the major issue. At the end of Q2, the company still had over 3,100 unsold homes with an aggregate value north of $1 billion in its inventory. Competitor Opendoor Technologies (OPEN $24), meanwhile, purchased over 8,000 homes in Q2 and has contracts on another 8,000 or so. It should be noted that Opendoor just went public last December, and is using the infusion of cash from its IPO to help purchase the large number of homes.
There are a number of different aspects to this story (to include how these iBuyers get paid), which we will delve into deeper in the next Penn Wealth Report. In short, we don't necessarily believe the pullback presents a good buying opportunity. Investors clearly thought the pause was a negative, shedding Z shares and buying OPEN shares on the news. Opendoor, which has yet to turn a profit, suddenly finds itself with a market cap of nearly $15 billion. It takes some creative math to justify that valuation, especially if the specter of higher rates coupled with skyrocketing home prices begin to keep would-be buyers at bay.
Cryptocurrencies
07. You may love bitcoin, but that doesn't mean you should buy into BITO, the first bitcoin-focused ETF
Crypto enthusiasts may be thrilled that a bitcoin-centric exchange traded fund has finally arrived, but there are a few things to consider about the ProShares Bitcoin Strategy ETF (BITO $43) before taking a bite. First and foremost, this is not an investment in the crypto itself; rather, it is a derivative which makes a bet on bitcoin futures. Each month, the futures contracts held by the ETF will expire, forcing them to roll into the following month's contracts. This gets into a potentially disastrous situation known as contango—a condition in which the future price of a commodity is higher than the spot (current) price. That is exactly where we sit right now with respect to bitcoin. Of course, the opposite condition, known as backwardation, could also come into play; this is where the spot price of the asset is higher than the its futures price. Another reason crypto investors may want to steer clear is the fact that crypto bears will be able to short BITO, dragging down its price despite the current value of the underlying asset. For sure, the ETF's successful first day (it rose 5% from its $40 initial NAV) helped bitcoin prices rise to new highs, but don't expect the crypto to return the favor for investors in this volatile new vehicle.
The cleanest way to buy bitcoin is to open a digital wallet via an app such as Coinbase. Or, better yet in our opinion, buy some Coinbase (COIN $314) itself, and take advantage of the moves in other cryptos. While the Grayscale Bitcoin Trust (GBTC $52) may seem like a common sense solution, this is also a derivative tracking vehicle for the coin, not a direct investment. That being said, Grayscale has filed to turn the biggest bitcoin fund into an ETF, but that is dependent upon the good graces of one of the biggest crypto critics out there: Gary Gensler's SEC. Once again, we would steer would-be crypto bugs to Coinbase.
Automotive
06. After landing enormous Hertz deal, Tesla officially reaches the rarified air of the $1T market cap club
Our favorite graph of EV leader Tesla (TSLA $1,025), surprisingly, isn't the company's share price; rather, it is the percentage of shares held short. In other words, a visual of the percentage of investors betting against the company. We can almost hear the ghost of CNBC's Mark Haines blathering, "Why the hell would anyone want to own this company?" Back in May of 2019, one out of every four shares of Tesla were held short; today, that number is under 3%. You can lose only so many hands before you are forced to walk away from the table. The latest news, which made Musk's vehicle technology firm one of only five American companies with a market cap exceeding $1 trillion (Apple, Microsoft, Alphabet, and Amazon are the others), was the announcement that car rental company Hertz (HTZZ $27) would buy a staggering 100,000 Teslas for nearly full price. Putting that in some perspective, that order would account for one out of every five vehicles the company sold in 2020. The news drove Tesla's share price up 12.66% on Monday, to a new high of $1,024.86, and brought its market cap up to $1.029 trillion. For Hertz, the deal represents a major strategic push to electrify its rental car fleet, to include building out its own charging infrastructure. The order, which will transpire over the next fourteen months, will add roughly $4.2 billion to Tesla's top line, meaning Hertz will pay around $42,000 for each vehicle. Tesla Model 3 sedans should be available to Hertz customers in the US and areas of Western Europe as soon as next month. Ironically, the interim CEO of Hertz is Mark Fields, the former CEO of Ford Motor Company (F $16).
For investors, this massive deal represents yet another reason to own shares of Tesla. The news also drove Hertz shares up 10% on the day, but recall that the firm was driven into bankruptcy during the height of the pandemic, just recently emerging. We love the company's strategic push to electrify its fleet, but the $27 share price seems a bit rich. They may be worth another look should they fall back into the teens.
Capital Markets
05. After quickly doubling in price, Robinhood shares come tumbling back to earth on earnings, forward guidance
The "trading platform for the masses," Robinhood (HOOD $34), has been on quite the ride since its summer IPO. After immediately falling 12% from its $38 IPO price, it ended up hitting an intra-day high (not reflected in the graph, which represents closing prices) of $85 per share on the 4th of August. It has been pretty much been of a downhill slide since then. The latest negative catalyst, which resulted in shares once again falling below their IPO price, was a brutal Q3 earnings report and dark forward guidance from management. Consider these headline numbers representing the difference between Q2 and Q3: Revenues fell from $565M to $365M; crypto-based revenues fell from $233M to $51M; net losses were $2.06/sh versus estimates of -$1.37/sh; monthly active users (MAU) fell from 21.3M to 18.9M. The icing on this rather ugly cake came in the form of forward guidance from management: "...factors may result in quarterly revenues no greater than $325M in the fourth quarter." As if the numbers weren't bad enough, there are other potential negative surprises waiting in the wings. A full 73% of the company's revenues emanated from payment for order flow (PFOF) in Q3, something the SEC is seriously considering placing a ban on. Only seven cryptos are available on the platform, as opposed to 50+ (and growing) on the Coinbase platform. On the first of December the lock-up period will expire for all shares, meaning insiders will be able to sell at will. At least management took a conservative approach on the conference call, giving a refreshingly sober review of the company's outlook—as opposed to using the typical hyperbole so common in many quarterly earnings releases.
Management freely admitted that two major events, the meme stock craze and the explosion in cryptos, helped fuel the company's success in the first two quarters of the year, and that it is virtually impossible to predict the next big event that will drive trading. Again, points for being honest, but we would stick with Coinbase (COIN $319) for anyone wishing to invest in a new exchange platform. Shares of the company are up 40% since we added it to the Intrepid Trading Platform—with a target price of $300.
Interactive Media & Services
04. What's in a name? Perhaps we are in the minority, but we are thrilled about Facebook morphing to Meta
Listening to David Faber (Little Lord Fauntleroy) of CNBC talk about Facebook's (FB $323) push into the metaverse reminded us of his mentor, the late Mark Haines, bashing Apple's new iPad back in 2014. There are creative souls who design and build the future, and then there are the naysayers telling us—every step along the way—all of the reasons failure is inevitable. As for Facebook's grand plans for its future, it all begins with a name change. On the 1st of December, the company Meta, formerly known as Facebook, will begin trading under the symbol MVRS. Predictably, the jeers began immediately after Zuckerberg announced the change, with many (if not most) claiming this was just an attempt to distract the focus away from the endless political attacks on the firm. We simply don't buy that. Already an owner of Oculus, the leading maker of virtual reality hardware, Facebook is ready to embrace the "next evolution of social technology," as the firm labels the metaverse. Imagine communicating and interacting with others not in the 2D environment of a Facebook app, but in a computer-generated digital environment. A "face-to-face" game of golf, a board meeting, "visiting" a digital clothing store—it will all be possible in this new virtual world. While a Faber or a Haines (were he still alive) could never generate the sparks of creativity required to envision such a place, the opportunities will be endless—for participants, involved companies, and investors. Zuckerberg said that the company will now be a "metaverse-first, not a Facebook-first, firm." To that end, Meta has already committed $10 billion to its Reality Labs division, and will begin breaking out the financial results for the two sides of the company. Our bet? As profitable and dominant a player Facebook has become, its metaverse division will, ultimately, eclipse its traditional business. There will be plenty of competition along the way, and we expect Apple (AAPL $150) to roll out its own metaverse hardware soon, but Facebook will be a major player in this nascent industry.
We vividly recall the ascent of the personal computer and, subsequently, the Internet. Both of these massive disruptors began as something of a gimmick in the minds of journalists and the business community. Consider how these two "gimmicks" have changed the way we live. Consider living and working through the pandemic without them. The potential of the metaverse is enormous; now is the time for astute investors to begin understanding what it is, and how it will weave its way into the fabric of society. As for MVRS, we can officially say we owned while it was still just a social media platform.
Supply, Demand, & Prices
03. Twitter's Jack Dorsey says hyperinflation is coming; we say he is not playing with a full deck
For anyone who hasn't seen a recent picture of Twitter (TWTR $54) and Square (SQ $255) CEO Jack Dorsey, picture a younger version of Howard Hughes shortly before his death. This brilliant economic mind has been studying the US and global landscape and has issued an edict from on high: "Hyperinflation is going to change everything. It's happening." Really? Yes, inflation is here, and for some very specific reasons—from a seemingly endless supply of new money to the temporarily-broken global supply chain; but hyperinflation? The textbook definition of the term is the persistent, rapidly-rising cost of goods and services, to the tune of over 50% per month. A textbook example of hyperinflation would be the conditions in the Weimar Republic in the 1920s, when the German government ran their printing presses nonstop. A loaf of bread that cost a shopper 250 marks in January of 1923 had risen to a price of 200 billion marks by November of that same year (a US dollar was worth roughly 1 trillion marks going into the month). Wages for German workers were renegotiated daily, as their pay was typically worthless by the following day. We doubt it is still taught in school, but many of us remember seeing the photos of German homeowners wallpapering their houses with worthless currency. That, Mr. Dorsey, is hyperinflation. What you are spewing is called hyperbole. To be sure, the Fed—and the Treasury Department and the politicians—should be concerned about the 5% inflation rate we have witnessed for the past three months. Instead of making silly claims, Mr. Dorsey (leave that to the real economists), focus on how you can better monetize your social media platform.
Speaking of Germany, inflation in that country just hit its highest mark in three decades: 4%. Perhaps the specter of inflation, which Germans are hypersensitive to considering past events, is the reason the 10-year German Bund is nearing 0%—on the way up, that is. Monetary policy around the world is in a state of wanton madness. Tightening needs to occur, but the markets won't like it when it finally happens. While the first rate hike may still be a year away, we could see the Fed tapering its $120B per month spending spree within the next three months. It will be fascinating to gauge how the markets react when it does.
Consumer Durables
02. Whirlpool is getting squeezed by higher input costs and supply chain troubles; is it time to buy?
"Elevated supply constraints" was the term management used during Whirlpool's (WHR $214) Q3 earnings conference call. Shares of America's largest consumer appliance maker fell more than 4% on the heels of the release, or about 22% off of their May highs. While revenues for the quarter ($5.5B) missed analyst expectations by 2%, they were still up 4% from the same quarter in 2020, and the company is still on pace to exceed—or at least match—its pre-pandemic annual revenues of $21 billion. As for net income, which was constricted due to higher wages and input costs, the company still made $471 in profit versus $392 million in Q3 of 2020. So, with its tiny multiple of 6.8, is the domestic maker of Whirlpool, KitchenAid, and Maytag appliances a buy? Arguably, yes. The housing market is still hot, and the strong demand for appliances has allowed the company to raise prices between 5% and 12% across the board to make up for the higher cost of raw materials. The company has also increased its stock repurchase program—a sign that management believes the shares are cheap—and maintained its healthy $1.40 per share dividend. Additionally, the Whirlpool name is highly respected throughout much of Latin America, a region which should be a nice driver for increased sales for years to come. The company's largest competitor in the Americas is GE Appliances, but that unit continues to struggle since General Electric (GE $106) sold it to a Chinese conglomerate five years ago. Despite investors' reaction to the Q3 earnings report, the future looks pretty bright for this 110-year-old Michigan-based company.
With its $13 billion market cap, Whirlpool is nestled snugly in the mid-cap value space—an area we are enamored with right now. Furthermore, we believe the company will retain its pricing power even as the supply chain issues abate, meaning expanded margins. We would place a fair value of WHR shares at $300, or 40% higher than where they trade right now.
Monetary Policy
01. The Fed just announced a refreshing move; even more refreshing was the market's muted reaction to the news
In June of 2020, we wrote of the Fed's announcement to continue buying $120 billion in bonds ($80 billion in Treasuries and $40 billion in mortgage-backed securities, or MBS) until the economic situation had stabilized to the point at which they could begin tapering those purchases. At the time, the Fed's balance sheet—which is part of our $28.9 trillion national debt—had already mushroomed from $4 trillion to $7 trillion. Today, as the Fed's balance sheet sits at $8.6 trillion, the big moment has arrived: Fed Chair Jerome Powell announced on Wednesday that the purchase program would be reduced by $15 billion ($10B Treasuries, $5B MBS) per month, beginning immediately. At this clip, the program would end entirely by June of 2022. Investors breathlessly awaited the market's reaction. Impressively, neither the stock market nor the bond market did much of anything in response. In fact, the major indexes actually began to strengthen into the close as Powell conducted his press briefing. It is refreshing to see that the move did not cause any type of "taper tantrum," as a similar move did back in 2013. Credit to the Fed for masterfully telegraphing the inevitability of this action. Now, let's see how the market reacts when rates begin to inch up, probably in the second half of next year.
It is depressing to look at America's national debt, especially knowing full well that it will ultimately have an enormous negative impact on this country's economy. While the Fed's move won't help reduce that load (at least until the program ends and some of the bonds begin to "fall off" of the balance sheet), it is somewhat comforting to know that it won't grow it at a guaranteed rate of $120 billion per month. Just as every family should be able to rattle off their total debt in an instant, every American should know how much debt their government holds. After all, we are all ultimately responsible for outstanding bill and its ever-accruing interest.
Under the Radar Investment
BorgWarner Inc (BWA $46)
BorgWarner is a mid-cap value company operating in the auto parts supply chain. It is a Tier 1 supplier, meaning it provides parts directly to the OEMs (original equipment manufacturers) such as Ford, Volkswagen, and Hyundai—its three main customers. The company has a masterful geographic diversification, with about one third of revenues coming from each: North America, Europe, and Asia. Due to its mix of products, innovative design team, and recent acquisition of Delphi Automotive, BorgWarner is very well positioned to take advantage of the industry trends toward lower emissions and a "greener" environment. It makes a number of parts and components for hybrid and electric vehicles. With its low multiple of 14 and excellent financial health, we find the company as attractive now as we did when we added it to the Penn Global Leaders Club precisely one year ago, 03 Nov 2020, at $36.57 per share.
Answer
Not only didn't you meet your objective, you didn't even buy from an American company which happens to produce its goods outside of the US. In 2016, General Electric sold their GE Appliances unit to Haier, a Chinese company. (Sidebar: We once purchased a Haier mini-fridge which failed to operate immediately upon removal from the shipping container.) A consumer visiting geappliances.com would be hard pressed to determine that these were not American-made goods.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Purpose-driven spending...
You just purchased a new home and need to select the appliances—refrigerator, washer and dryer, range, dishwasher, microwave—for the joint. You would like to buy products made in North America, Europe, Japan, or South Korea; four regions known for making quality consumer durables. You decide upon the GE Appliances line based on their century-old reputation. Did you meet your objective?
Penn Trading Desk:
Penn: Open educational services company in the Intrepid
We have followed this major American educational services company for the past five years and, while we found it overvalued at recent levels, found it irresistible after lowered guidance and an analyst cut sent shares plummeting. We added this mid-cap growth company to the Intrepid Trading Platform with an initial price target 53% higher than our purchase price, and a secondary price target double our purchase price.
Penn: Open communication services firm in the Global Leaders Club
Oddly enough, we haven't recently held any firms from the Communication Services sector in the Penn Global Leaders Club—a rare condition. We rectified that with a pickup of one of the most controversial companies in America. Here's the way we see it: this behemoth is an income-generating machine, dominates its segment, and has a bold strategic plan for its future. Political correctness be damned, we added this juggernaut to the portfolio with high expectations for future growth.
Penn: Open a US semiconductor powerhouse (not Intel) to the New Frontier Fund
There is a major (and much needed) push underway for increased domestic production of high-tech semiconductor devices and components. We added a US-based manufacturer which will play a major role in the Internet of Things (IoT), 5G, autonomous vehicles, and AI/VR to the New Frontier Fund.
Penn: Open a hammered booze company in the Intrepid
We have watched investors analyze booze companies incorrectly more times than we can count, and our most recent addition to the Penn Intrepid Trading Program is a glaring example. Making a few poor decisions, one on hard seltzer and another on a new beer launch, made investors lose faith; but management matters, and we fully expect this company's exemplary chairman of the board to right his ship.
Penn: Open a regional bank in the Strategic Income Portfolio
Based on the specter of rising rates and not-so-transitory inflation, we have increased our allocation within the Financials sector. To that end, we added a regional bank (Northeastern US) with a clean balance sheet and a hefty dividend yield to our income portfolio. Members, see the Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
eCommerce
10. Netflix is teaming up with Walmart to create a dedicated digital storefront on the retailing giant's website
As Netflix's (NFLX $624) subscriber growth cools, it continues to search for new revenue streams in an effort to become less reliant on the one metric analysts focus on each quarter. To that end, the company has announced a new deal with Walmart (WMT $141) which will result in a dedicated 'Netflix Hub' on the giant retailer's website. The shop will include themed merchandise from its wildly-successful "Squid Game" as well as other recent hits on the streaming service, such as "Stranger Things." Right now, Netflix receives the vast majority of its revenue from the $13.99 paid monthly (more or less, depending on subscription plan) by its 200 million subscribers around the world. The growth of that subscriber base has been leveling out, however, due to saturation and a host of new entrants in the space, from Disney+ to Amazon Prime Video. While CEO Reed Hastings said he doesn't expect the new venture to have a major impact on the company's top line, he believes the real value comes in building user engagement with and excitement for the provider's Netflix Originals, for which it currently spends over $5 billion per year developing. Netflix licenses its intellectual property to select manufacturers in exchange for a cut of the profit. As for Walmart, this deal is part of an overall strategy to increase its online Walmart Marketplace presence by teaming up with brands held in high esteem by consumers. Like the recent deal with Gap, the company hopes to broaden its customer base by attracting a new generation of consumers; primarily younger customers who might have avoided the company's site in the past.
Based on valuations and our current tilt toward more conservative names, we believe Walmart shares look more attractive right now than those of its new marketing partner, Netflix. When another downturn hits the market, we could see NFLX shares falling back into the $400s—at which time they would be worthy of another look.
Communication Services
09. Over the course of twenty years, AT&T shares have dropped 43%; is it time to buy?
Our stop-loss order on AT&T (T $26) shares finally hit this past May at $32, ending a miserable period of holding the once-great telecom company. That stop was fortuitous, as shares have dropped to $26 since we dumped them. At least we had the fat dividend yield (now at 8% based on the share price, though it will be adjusted down after spinoffs), but that is about the only positive aspect of owning the shares since we picked them up. Our super-long-term 26% gain was not worth the wait; the opportunity cost was tremendous. In fact, an investment in the S&P 500 twenty years ago would have given investors just shy of a 500% return, while the same investment in T shares would have lost nearly 50% after two decades, sans the dividend.
Enormous missteps by management—like overpaying for acquisitions they could never quite make fit into the T puzzle, and ignoring serious problems with customer service due to sheer arrogance—have brought us to this point. Other telecom companies have proven that industry flux is not the issue; poor management is the root cause. So, with the shares "dirt cheap," as some analysts have called them, is it time to bet on the storied company? The argument for purchase revolves around the company's plan to slim down and focus its efforts exclusively on telecom services, mainly its 5G wireless network. It already ditched its wildly-expensive DirecTV unit and is about to spinoff its WarnerMedia division, which will become Warner Bros. Discovery. But we have three major arguments against the bull case. First, the company still has a massive debt load of $180 billion, which will only be negligibly alleviated by the Warner spinoff. Second, the company's area of focus going forward is going to be hyper-competitive thanks to new technologies and entrants. Finally, we have about as much faith in the management team at T as we do in the team at Boeing.
It is certainly tempting to pick up shares of T at $26, but we have seen the stock languish for too long to get excited here. It may end up being a multiyear low price, but there are simply too many obstacles facing the lackluster leadership team.
Homes & Durables
08. Zillow falls double digits as it presses pause on its home buying program; competitor Opendoor Technologies jumps*
(UPDATE: Zillow has announced it has exited the home flipping business altogether, sending shares tumbling another 25% on Wednesday. Considering the percentage of revenues generated by the unit, we are even more concerned now than when we wrote this piece on Monday.)
It didn't strike us as a viable reason for the company's shares to fall over 10%, but Zillow's (Z $65) announcement that it would hold off on buying any more homes while it works through a backlog of properties caused the shares to tumble on Monday. Zillow Offers, the company's high-tech buying and flipping unit, purchased nearly 4,000 homes in the second quarter of the year. And the unit is hardly an afterthought: it produced $772 million of the $1.31 billion—or 60%—in total revenue generated over the three-month period. With that in mind, why would management bring buying to a screeching halt? The answer, according to management, revolves around what the company does after purchasing the properties.
One of the biggest headaches for sellers involves evaluating what needs to be repaired or replaced in a home before it is listed. Using its proprietary home value algorithms, Zillow will make homeowners an offer on the spot—no repair or staging required. This means that the company must perform the repairs and prepare the house for sale. While it won't invest in homes with extensive damage or with major needed repairs, COO Jeremy Wacksman told investors that labor and supply constraints have been the major issue. At the end of Q2, the company still had over 3,100 unsold homes with an aggregate value north of $1 billion in its inventory. Competitor Opendoor Technologies (OPEN $24), meanwhile, purchased over 8,000 homes in Q2 and has contracts on another 8,000 or so. It should be noted that Opendoor just went public last December, and is using the infusion of cash from its IPO to help purchase the large number of homes.
There are a number of different aspects to this story (to include how these iBuyers get paid), which we will delve into deeper in the next Penn Wealth Report. In short, we don't necessarily believe the pullback presents a good buying opportunity. Investors clearly thought the pause was a negative, shedding Z shares and buying OPEN shares on the news. Opendoor, which has yet to turn a profit, suddenly finds itself with a market cap of nearly $15 billion. It takes some creative math to justify that valuation, especially if the specter of higher rates coupled with skyrocketing home prices begin to keep would-be buyers at bay.
Cryptocurrencies
07. You may love bitcoin, but that doesn't mean you should buy into BITO, the first bitcoin-focused ETF
Crypto enthusiasts may be thrilled that a bitcoin-centric exchange traded fund has finally arrived, but there are a few things to consider about the ProShares Bitcoin Strategy ETF (BITO $43) before taking a bite. First and foremost, this is not an investment in the crypto itself; rather, it is a derivative which makes a bet on bitcoin futures. Each month, the futures contracts held by the ETF will expire, forcing them to roll into the following month's contracts. This gets into a potentially disastrous situation known as contango—a condition in which the future price of a commodity is higher than the spot (current) price. That is exactly where we sit right now with respect to bitcoin. Of course, the opposite condition, known as backwardation, could also come into play; this is where the spot price of the asset is higher than the its futures price. Another reason crypto investors may want to steer clear is the fact that crypto bears will be able to short BITO, dragging down its price despite the current value of the underlying asset. For sure, the ETF's successful first day (it rose 5% from its $40 initial NAV) helped bitcoin prices rise to new highs, but don't expect the crypto to return the favor for investors in this volatile new vehicle.
The cleanest way to buy bitcoin is to open a digital wallet via an app such as Coinbase. Or, better yet in our opinion, buy some Coinbase (COIN $314) itself, and take advantage of the moves in other cryptos. While the Grayscale Bitcoin Trust (GBTC $52) may seem like a common sense solution, this is also a derivative tracking vehicle for the coin, not a direct investment. That being said, Grayscale has filed to turn the biggest bitcoin fund into an ETF, but that is dependent upon the good graces of one of the biggest crypto critics out there: Gary Gensler's SEC. Once again, we would steer would-be crypto bugs to Coinbase.
Automotive
06. After landing enormous Hertz deal, Tesla officially reaches the rarified air of the $1T market cap club
Our favorite graph of EV leader Tesla (TSLA $1,025), surprisingly, isn't the company's share price; rather, it is the percentage of shares held short. In other words, a visual of the percentage of investors betting against the company. We can almost hear the ghost of CNBC's Mark Haines blathering, "Why the hell would anyone want to own this company?" Back in May of 2019, one out of every four shares of Tesla were held short; today, that number is under 3%. You can lose only so many hands before you are forced to walk away from the table. The latest news, which made Musk's vehicle technology firm one of only five American companies with a market cap exceeding $1 trillion (Apple, Microsoft, Alphabet, and Amazon are the others), was the announcement that car rental company Hertz (HTZZ $27) would buy a staggering 100,000 Teslas for nearly full price. Putting that in some perspective, that order would account for one out of every five vehicles the company sold in 2020. The news drove Tesla's share price up 12.66% on Monday, to a new high of $1,024.86, and brought its market cap up to $1.029 trillion. For Hertz, the deal represents a major strategic push to electrify its rental car fleet, to include building out its own charging infrastructure. The order, which will transpire over the next fourteen months, will add roughly $4.2 billion to Tesla's top line, meaning Hertz will pay around $42,000 for each vehicle. Tesla Model 3 sedans should be available to Hertz customers in the US and areas of Western Europe as soon as next month. Ironically, the interim CEO of Hertz is Mark Fields, the former CEO of Ford Motor Company (F $16).
For investors, this massive deal represents yet another reason to own shares of Tesla. The news also drove Hertz shares up 10% on the day, but recall that the firm was driven into bankruptcy during the height of the pandemic, just recently emerging. We love the company's strategic push to electrify its fleet, but the $27 share price seems a bit rich. They may be worth another look should they fall back into the teens.
Capital Markets
05. After quickly doubling in price, Robinhood shares come tumbling back to earth on earnings, forward guidance
The "trading platform for the masses," Robinhood (HOOD $34), has been on quite the ride since its summer IPO. After immediately falling 12% from its $38 IPO price, it ended up hitting an intra-day high (not reflected in the graph, which represents closing prices) of $85 per share on the 4th of August. It has been pretty much been of a downhill slide since then. The latest negative catalyst, which resulted in shares once again falling below their IPO price, was a brutal Q3 earnings report and dark forward guidance from management. Consider these headline numbers representing the difference between Q2 and Q3: Revenues fell from $565M to $365M; crypto-based revenues fell from $233M to $51M; net losses were $2.06/sh versus estimates of -$1.37/sh; monthly active users (MAU) fell from 21.3M to 18.9M. The icing on this rather ugly cake came in the form of forward guidance from management: "...factors may result in quarterly revenues no greater than $325M in the fourth quarter." As if the numbers weren't bad enough, there are other potential negative surprises waiting in the wings. A full 73% of the company's revenues emanated from payment for order flow (PFOF) in Q3, something the SEC is seriously considering placing a ban on. Only seven cryptos are available on the platform, as opposed to 50+ (and growing) on the Coinbase platform. On the first of December the lock-up period will expire for all shares, meaning insiders will be able to sell at will. At least management took a conservative approach on the conference call, giving a refreshingly sober review of the company's outlook—as opposed to using the typical hyperbole so common in many quarterly earnings releases.
Management freely admitted that two major events, the meme stock craze and the explosion in cryptos, helped fuel the company's success in the first two quarters of the year, and that it is virtually impossible to predict the next big event that will drive trading. Again, points for being honest, but we would stick with Coinbase (COIN $319) for anyone wishing to invest in a new exchange platform. Shares of the company are up 40% since we added it to the Intrepid Trading Platform—with a target price of $300.
Interactive Media & Services
04. What's in a name? Perhaps we are in the minority, but we are thrilled about Facebook morphing to Meta
Listening to David Faber (Little Lord Fauntleroy) of CNBC talk about Facebook's (FB $323) push into the metaverse reminded us of his mentor, the late Mark Haines, bashing Apple's new iPad back in 2014. There are creative souls who design and build the future, and then there are the naysayers telling us—every step along the way—all of the reasons failure is inevitable. As for Facebook's grand plans for its future, it all begins with a name change. On the 1st of December, the company Meta, formerly known as Facebook, will begin trading under the symbol MVRS. Predictably, the jeers began immediately after Zuckerberg announced the change, with many (if not most) claiming this was just an attempt to distract the focus away from the endless political attacks on the firm. We simply don't buy that. Already an owner of Oculus, the leading maker of virtual reality hardware, Facebook is ready to embrace the "next evolution of social technology," as the firm labels the metaverse. Imagine communicating and interacting with others not in the 2D environment of a Facebook app, but in a computer-generated digital environment. A "face-to-face" game of golf, a board meeting, "visiting" a digital clothing store—it will all be possible in this new virtual world. While a Faber or a Haines (were he still alive) could never generate the sparks of creativity required to envision such a place, the opportunities will be endless—for participants, involved companies, and investors. Zuckerberg said that the company will now be a "metaverse-first, not a Facebook-first, firm." To that end, Meta has already committed $10 billion to its Reality Labs division, and will begin breaking out the financial results for the two sides of the company. Our bet? As profitable and dominant a player Facebook has become, its metaverse division will, ultimately, eclipse its traditional business. There will be plenty of competition along the way, and we expect Apple (AAPL $150) to roll out its own metaverse hardware soon, but Facebook will be a major player in this nascent industry.
We vividly recall the ascent of the personal computer and, subsequently, the Internet. Both of these massive disruptors began as something of a gimmick in the minds of journalists and the business community. Consider how these two "gimmicks" have changed the way we live. Consider living and working through the pandemic without them. The potential of the metaverse is enormous; now is the time for astute investors to begin understanding what it is, and how it will weave its way into the fabric of society. As for MVRS, we can officially say we owned while it was still just a social media platform.
Supply, Demand, & Prices
03. Twitter's Jack Dorsey says hyperinflation is coming; we say he is not playing with a full deck
For anyone who hasn't seen a recent picture of Twitter (TWTR $54) and Square (SQ $255) CEO Jack Dorsey, picture a younger version of Howard Hughes shortly before his death. This brilliant economic mind has been studying the US and global landscape and has issued an edict from on high: "Hyperinflation is going to change everything. It's happening." Really? Yes, inflation is here, and for some very specific reasons—from a seemingly endless supply of new money to the temporarily-broken global supply chain; but hyperinflation? The textbook definition of the term is the persistent, rapidly-rising cost of goods and services, to the tune of over 50% per month. A textbook example of hyperinflation would be the conditions in the Weimar Republic in the 1920s, when the German government ran their printing presses nonstop. A loaf of bread that cost a shopper 250 marks in January of 1923 had risen to a price of 200 billion marks by November of that same year (a US dollar was worth roughly 1 trillion marks going into the month). Wages for German workers were renegotiated daily, as their pay was typically worthless by the following day. We doubt it is still taught in school, but many of us remember seeing the photos of German homeowners wallpapering their houses with worthless currency. That, Mr. Dorsey, is hyperinflation. What you are spewing is called hyperbole. To be sure, the Fed—and the Treasury Department and the politicians—should be concerned about the 5% inflation rate we have witnessed for the past three months. Instead of making silly claims, Mr. Dorsey (leave that to the real economists), focus on how you can better monetize your social media platform.
Speaking of Germany, inflation in that country just hit its highest mark in three decades: 4%. Perhaps the specter of inflation, which Germans are hypersensitive to considering past events, is the reason the 10-year German Bund is nearing 0%—on the way up, that is. Monetary policy around the world is in a state of wanton madness. Tightening needs to occur, but the markets won't like it when it finally happens. While the first rate hike may still be a year away, we could see the Fed tapering its $120B per month spending spree within the next three months. It will be fascinating to gauge how the markets react when it does.
Consumer Durables
02. Whirlpool is getting squeezed by higher input costs and supply chain troubles; is it time to buy?
"Elevated supply constraints" was the term management used during Whirlpool's (WHR $214) Q3 earnings conference call. Shares of America's largest consumer appliance maker fell more than 4% on the heels of the release, or about 22% off of their May highs. While revenues for the quarter ($5.5B) missed analyst expectations by 2%, they were still up 4% from the same quarter in 2020, and the company is still on pace to exceed—or at least match—its pre-pandemic annual revenues of $21 billion. As for net income, which was constricted due to higher wages and input costs, the company still made $471 in profit versus $392 million in Q3 of 2020. So, with its tiny multiple of 6.8, is the domestic maker of Whirlpool, KitchenAid, and Maytag appliances a buy? Arguably, yes. The housing market is still hot, and the strong demand for appliances has allowed the company to raise prices between 5% and 12% across the board to make up for the higher cost of raw materials. The company has also increased its stock repurchase program—a sign that management believes the shares are cheap—and maintained its healthy $1.40 per share dividend. Additionally, the Whirlpool name is highly respected throughout much of Latin America, a region which should be a nice driver for increased sales for years to come. The company's largest competitor in the Americas is GE Appliances, but that unit continues to struggle since General Electric (GE $106) sold it to a Chinese conglomerate five years ago. Despite investors' reaction to the Q3 earnings report, the future looks pretty bright for this 110-year-old Michigan-based company.
With its $13 billion market cap, Whirlpool is nestled snugly in the mid-cap value space—an area we are enamored with right now. Furthermore, we believe the company will retain its pricing power even as the supply chain issues abate, meaning expanded margins. We would place a fair value of WHR shares at $300, or 40% higher than where they trade right now.
Monetary Policy
01. The Fed just announced a refreshing move; even more refreshing was the market's muted reaction to the news
In June of 2020, we wrote of the Fed's announcement to continue buying $120 billion in bonds ($80 billion in Treasuries and $40 billion in mortgage-backed securities, or MBS) until the economic situation had stabilized to the point at which they could begin tapering those purchases. At the time, the Fed's balance sheet—which is part of our $28.9 trillion national debt—had already mushroomed from $4 trillion to $7 trillion. Today, as the Fed's balance sheet sits at $8.6 trillion, the big moment has arrived: Fed Chair Jerome Powell announced on Wednesday that the purchase program would be reduced by $15 billion ($10B Treasuries, $5B MBS) per month, beginning immediately. At this clip, the program would end entirely by June of 2022. Investors breathlessly awaited the market's reaction. Impressively, neither the stock market nor the bond market did much of anything in response. In fact, the major indexes actually began to strengthen into the close as Powell conducted his press briefing. It is refreshing to see that the move did not cause any type of "taper tantrum," as a similar move did back in 2013. Credit to the Fed for masterfully telegraphing the inevitability of this action. Now, let's see how the market reacts when rates begin to inch up, probably in the second half of next year.
It is depressing to look at America's national debt, especially knowing full well that it will ultimately have an enormous negative impact on this country's economy. While the Fed's move won't help reduce that load (at least until the program ends and some of the bonds begin to "fall off" of the balance sheet), it is somewhat comforting to know that it won't grow it at a guaranteed rate of $120 billion per month. Just as every family should be able to rattle off their total debt in an instant, every American should know how much debt their government holds. After all, we are all ultimately responsible for outstanding bill and its ever-accruing interest.
Under the Radar Investment
BorgWarner Inc (BWA $46)
BorgWarner is a mid-cap value company operating in the auto parts supply chain. It is a Tier 1 supplier, meaning it provides parts directly to the OEMs (original equipment manufacturers) such as Ford, Volkswagen, and Hyundai—its three main customers. The company has a masterful geographic diversification, with about one third of revenues coming from each: North America, Europe, and Asia. Due to its mix of products, innovative design team, and recent acquisition of Delphi Automotive, BorgWarner is very well positioned to take advantage of the industry trends toward lower emissions and a "greener" environment. It makes a number of parts and components for hybrid and electric vehicles. With its low multiple of 14 and excellent financial health, we find the company as attractive now as we did when we added it to the Penn Global Leaders Club precisely one year ago, 03 Nov 2020, at $36.57 per share.
Answer
Not only didn't you meet your objective, you didn't even buy from an American company which happens to produce its goods outside of the US. In 2016, General Electric sold their GE Appliances unit to Haier, a Chinese company. (Sidebar: We once purchased a Haier mini-fridge which failed to operate immediately upon removal from the shipping container.) A consumer visiting geappliances.com would be hard pressed to determine that these were not American-made goods.
Headlines for the Week of 29 Aug—04 Sep 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Turning point of the American Revolution...
Despite Washington's impressive Revolutionary War victory against the German Hessians on December 26th, 1776 in the town of Trenton, there wasn't much to celebrate during the brutal months to come. What stunning victory began to turn the tide in favor of the Americans and convinced the French to join the fight against their longstanding nemesis, Great Britain?
Penn Trading Desk:
Penn: Changes to mining companies within the Global Leaders Club
After performing a review of the Metals & Mining industry, we are removing the two gold miners currently in the Penn Global Leaders Club and replacing them with an alternate name. Instead of an outright sell order, we recommend placing stops on the current positions slightly below their current respective prices. Members, see the Trading Desk for specific instructions. As always, clients of Penn Wealth Management, our Registered Investment Advisory service and a separate entity, will automatically have these actions taken.
JP Morgan: Add Sunrun to "U.S. Analyst Focus List"
JP Morgan just added $10 billion solar energy and storage company Sunrun (RUN $47) to its highest conviction group of names, the U.S. Analyst Focus List. Analyst Mark Strouse likes the fundamentals for the industry over the medium and long term, and believes supply constraints will ease in the second half of the year. While the risk, as measured by beta, is a quite large 2.089, the median target share price among analysts covering the stock is $76.53, or 62% higher from here. We listed some of our favorite clean energy plays in a recent Penn Wealth Report.
Cowen: Raise rating and price target on Textron
Citing a strong comeback in the demand for business jets and the nascent civilian VTOL (vertical take-off and landing) movement, Cowen has raised its rating on aviation firm Textron from Market Perform to Outperform, and has adjusted its target price for TXT shares from $75 to $95. That is a street high, with Morningstar taking the opposite side of the bet with its one-star rating and $42 per share target price. The average price target among the eleven analysts weighing in on the Rhode Island-based firm is $78 per share.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. In a refreshing twist, Coinbase's CEO fires back at SEC
We are ambivalent with respect to cryptos: their future as a means of exchange feels certain, but the industry is going through its Wild West phase right now, with plenty of risks and opportunities for investors. We are equally ambivalent about the SEC (and most other government agencies as well): they enforce needed guardrails, yet they too often create more problems than they resolve. Which leads to the brouhaha going on right now between the SEC and Coinbase (COIN $257), the leading crypto exchange platform in the United States and a current member of the Penn Intrepid Trading Platform. Shares of the exchange fell sharply this week as the SEC warned that it planned to sue if the company forged ahead with plans to allow its users—of which it currently boasts some 68 million—to earn interest by lending crypto assets. Apparently the SEC believes that privilege should rest solely in the hands of the banks. It is crystal clear that current SEC Chairman Gary Gensler plans on doing battle with a host of financial services companies during his reign, with cryptos, perhaps, being his number one target.
When a company receives a Wells Notice, a formal notice from the SEC informing the recipient that the agency is preparing enforcement actions, it is traditional to stay relatively mum; certainly not to stir the pot. Apparently, Coinbase CEO Brian Armstrong is taking a page from Elon Musk's playbook, as he remained anything but mum following the announcement. In what Bloomberg described as "a rant" and "a fit" (it was neither, Bloomberg), Armstrong unloaded on the commission. In one tweet, the dynamic CEO noted "Some really sketchy behavior coming out of the SEC recently. Story time...." Ironically, it was Coinbase's willingness to share its plans for the new lending platform with the SEC—instead of pushing ahead and implementing the plan—which instigated the threats from the government body. Instead of a few polite questions to delve further into how the process would work, the SEC, i.e. Gensler, took the very public action of issuing the Wells Notice. Not cool, SEC. Jesse Powell, co-founder of the crypto exchange Kraken, came to Armstrong's defense in his own series of tweets: "We won't tell you why we think your product is illegal but we will tell you that there is no path to making it legal. Disagree? Go ahead and see what happens." CEOs daring to fight back against government regulators? Brilliant! While the zeitgeist seems to consist of corporate heads cowardly genuflecting to any and all social movements looking their way, it is refreshing to see a little gutsy pushback against the tactics of bullies. That used to be called The American Spirit.
Despite the SEC-caused downturn in the stock, our COIN position is still up 10% since purchase. We fully expect the firm to weather this storm. We doubt the SEC fully understands how the crypto exchanges even work, so it will buy some time while the government attorneys attempt to get up to speed. After that, let the lengthy court battles begin.
Beverages & Tobacco
09. Tilray's convoluted effort to get its foot in the door of the US cannabis market
We have mentioned before our deep respect for Irwin Simon, founder of Hain Celestial (HAIN $40) and current CEO of Canadian cannabis company Tilray (TLRY $14). That being said, we do not currently own any specific cannabis names within any of the Penn portfolios. It's not that we don't believe in the future of the industry from an investment standpoint; we are simply waiting for the winners to break free from the inevitable losers. We expect Tilray to be a long-term player, but it doesn't yet have the ability to crack the lucrative US market. The company is trying to change that. As a Canadian cannabis company dual listed on the Toronto Exchange and the Nasdaq, the fact that cannabis is still illegal in the US at the federal level precludes Tilray from setting up operations south of their current border. So, in a complex, circuitous route, management just made a very interesting move. They acquired around $170 million of convertible MedMen (MMNFF $0.29) debt through a new limited partnership, with the debt's maturity date being extended out through August of 2028. MedMen is the preeminent cannabis player in the US, with access to roughly 50% of the total addressable (legal) market. The firm has major operations in California, Nevada, and New York. What does this mean for Tilray? The company's CEO made it pretty clear in recent comments: he believes that his Canadian entity will be able to acquire control of MedMen once cannabis is legalized at the federal level. Acquiring $170 million in debt for a micro-cap player in the US may not seem that big of a deal, but we fully expect the adroit Simon to leverage it into a major piece of the action as the domestic market for cannabis expands.
While we have played with positions in Tilray as well as Canopy Growth Corp (CGC $18), another major Canadian player, we have yet to add a cannabis company to a portfolio. MedMen may look attractive to some investors, but its current $0.29 share price represents a dramatic fall from the high of $1.47 it hit in February of this year. All of these firms remain huge money losers, though the space is worth keeping an eye on.
Aerospace & Defense
08. The last major aviation market refusing to lift ban on 737 MAX should come as no surprise
We have certainly given aircraft maker Boeing (BA $218) a lot of grief over the past two years, but this is a story more about politics than aviation prowess. Most other major aviation markets lifted the ban on the Boeing 737 MAX late last year or early in 2021, with two notable exceptions: India and China. This week, India's Directorate General of Civil Aviation announced that the model has received the green light to resume operations in that country, leaving only China's ban in place. Boeing's management team clearly believes the Chinese market is crucial for the company's growth story going forward, with one-fifth of the firm's aircraft deliveries since 2017 heading to the communist nation. But the trade war, the pandemic, and China's own economic ambitions have strongly constricted sales, leaving primarily Airbus (EADSY $34) to pick up the slack. China wants that situation to change as well, touting its own manufacturer, the Commercial Aircraft Corporation of China, or Comac. The company's nascent efforts, the ARJ21 and the C919—the latter of which it hopes can go head to head with the 737 MAX and the Airbus A320, have been riddled with defects and delays. The problems have kept would-be buyers at bay, despite the C919 selling for about half as much ($50 million) as the Airbus A320neo. Nonetheless, China, through its Belt and Road infrastructure initiative, will pump as much money as needed into Comac until it shows signs of life. As for the MAX, China would love to have Comac's C919 step in to fill the void, but it is unlikely that will happen anytime soon. Expect a lift on the ban to come—out of pure necessity—by the end of the year.
Boeing is facing a host of serious problems; a new competitor in the form of a state-sponsored Chinese aircraft manufacturer is one we haven't even touched on before. CEO David Calhoun is actively pushing the Biden administration to urge China to lift its ban on the MAX, but what really needs to be taking place is more activism in the ranks of BA shareholders to force an overhaul of Boeing's board of directors—including its president and CEO—Calhoun.
Demographics & Lifestyle
07. China limits videogame usage to three hours per week for minors, no play Monday through Thursday
Our first thought was, "Imagine trying to implement such a law in the U.S." China, as part of its latest salvo against industries it deems harmful to the collective cause, has issued a rather remarkable decree: minors—we are assuming that means youth under the age of eighteen—are hereby forbidden from playing videogames Monday through Thursday, and will limit their play to a maximum of one hour per day on Fridays, weekends, and public holidays, between the hours of 8 p.m. and 9 p.m. The ruling communist party claims that the "youth videogame addiction" is distracting young people from their responsibilities to school and family. How on earth does the government plan on enforcing this new dictate? Since the government controls the tech companies which operate in China, and these companies can control users via login credentials, the task isn't as herculean as it may seem. Just how granular is the government willing to get with respect to controlling its population? A few years back, videogame players between the ages of 16 and 18 were told that they could not spend over 400 yuan (about $60) per month on the purchase of new games.
At first blush, we imagine many Americans applaud such a move to restrict the brain-numbing play of videogames by a country's youth. However, a government which can and will control such a mundane aspect of life will never reach a level of satisfaction; lines in the sand will be just that, and they will be redrawn at the whim of the ruling members of the party. Personal freedoms will continue to wither away until an inevitable clash occurs between the masses being controlled and the elites who are imposing the draconian standards. China believes it can simultaneously control and feast off of the golden goose of economic prosperity. That faulty logic stems from the incredible level of arrogance and hubris which communism foments among its ruling class. The short-term pain we so often experience in a democracy is allowed to mushroom out of control within a closed society. Despite the lessons of the past, this is a condition lost on many within the financial media; journalists who eagerly regurgitate what the state-controlled media in China feeds them. As for the Chinese Internet companies which so many investors have been wantonly rushing into, many are now sitting 50% below their February highs on the heels of this latest government crackdown.
Application & Systems Software
06. Skittish investors drive Zoom Video shares down 25% in August
It is hard to believe, but it was just one year ago that investors were betting the farm on the future of Zoom Video Communications (ZM $289), driving shares up to astronomical valuations. After all, the company just happened to offer the exact right services at precisely the right time: a way for teachers to connect with students and for management to collaborate with workers in a world where schools and offices had been shut down due to the pandemic. It's not as though the company won't continue to excel, or that the health threat is behind us; it's more a case of investors' euphoria giving way to the reality of kids and workers going back to their respective schools and offices. Tuesday accounted for the second-largest one-day drop in Zoom's short history, with shares falling 17%, but August has been particularly brutal as the company lost about one-quarter of its market cap. But was it ever really deserving of the $160 billion market cap it held in October of last year, and does $86 billion signal a golden buying opportunity? The answer to both questions is, in our opinion, "no." Putting its size in perspective, ZM is nestled between banking stalwart US Bancorp (USB) and aerospace giant Lockheed Martin (LMT). That's hard to justify; but, then again, it makes more sense that AMC Entertainment (AMC) having a $24 billion market cap. (The latter was a $450 million company teetering on the brink of bankruptcy going into this year.)
Ironically, Zoom's big drop came after the company reported revenue of over $1 billion in the second quarter of the year, handily topping estimates. That figure represents a 54% gain over the same quarter last year, and a 700% gain over the same quarter in 2019. It was the guidance, however, that spooked investors. Subscribers are dropping off at an unexpected rate, and management warned that revenues would probably remain flat through the end of the year. Even after the August drop, Zoom's P/E ratio is still a lofty 100, but at least it has a multiple—unlike AMC.
We have a lot of respect for Zoom and its management team, and the company's long-term viability is not in question. However, there are so many other massive competitors getting into the space—from Microsoft to Google to Cisco—that it will be a street fight going forward. As the firm rolls out new services, such as Zoom Phone, it will grow into its multiple, but that would indicate it is rather fairly valued right around where it sits today.
Capital Markets
05. Robinhood investors should be concerned about recent comments made by the new SEC chairman
I recall would-be clients, early in my career, telling me that "we own American Century no-load mutual funds, so we don't pay any fees." My retort was always the same: "I wonder how they paid for those two beautiful towers where their headquarters is located, or how they pay their staff?" In reality, despite the flowery ads designed to make us think that a company's sole existence is to help others, it's always about the money. I thought of those comments, made to me in the late 1990s, as I read about the latest threat to newly-public Robinhood Markets (HOOD $44). As the financial services platform offers customers commission-free trading, where does the revenue come from? Overwhelmingly, the answer lies in something called payments for order flow (PFOF).
When a customer wishes to buy or sell shares of a company or to trade options, the broker—be it Robinhood, Schwab, or a host of others—forwards the trade to a market maker. Historically, these intermediaries were at the major exchanges, such as the New York Stock Exchange. More recently, however, a slew of off-exchange market makers have popped up and are now responsible for over half of all retail trades placed. They make their money off of the difference between what they pay to buy the requested shares and what they sell them for seconds later—the spread. Understandably, the higher the volume of orders flowing through a market maker, the more profit to be made. Since companies like Robinhood can choose who handles a given trade, these third-party market makers have been offering to share a percentage of the spread with the brokers; hence, payments for order flow. In one month alone, Robinhood reportedly generated $100 million in revenue via this practice.
Many of the larger brokerages, such as Fidelity and Interactive Brokers, generally refuse to accept PFOF. In fact, countries like Canada, Australia, and the U.K. have gone so far as to ban the practice altogether. Enter SEC Chairman Gary Gensler. In a Barron's interview, Gensler said that a ban on PFOF is "on the table." Transparency seems to be the term du jour in the financial services world, which means an ultimate U.S. ban is quite possible. For Robinhood, which makes a majority of its revenue from PFOF, this would be a disastrous course of events.
With HOOD shares trading nearly 50% off of their August high of $85, investors might be tempted to jump in. We are sticking by our previous comments, however, and would wait to see a price in the mid-$20s range before considering a new stake.
Media & Entertainment
04. Joke of the Week: GameStop headed back to the S&P 500?
It doesn't take much news, if any, to make a meme stock gyrate wildly in price, but the reason behind the most recent leg up in shares of GameStop (GME $214) is rather humorous. It seems a rumor began circulating that the reddit darling may be headed back to the S&P 500, the index which gave the company the boot back in 2016 due to deteriorating fundamentals. Granted, five years ago the videogame consumer retailer had dropped in size to $2.5 billion (it is now comically valued at $15 billion), but it was also generating over $9 billion in revenue and was operating in the black. Now, the company's sales are about half that amount and it hasn't turned a profit in over three years. That in itself should keep it out of the index, which requires an entrant to have positive earnings for not only the most recent quarter (GME lost $67 million), but also for the most recent four quarters in aggregate (GME lost $116 million TTM). Membership into the S&P 500 is not a matter of quant calculations; ultimately, an index committee made up of staffers at S&P Dow Jones Indices decide a company's fate. Bloggers and reddit users can speculate all they want, generally driving the price up as they do, but the odds of seeing ticker GME in the S&P 500 ever again are slim to none.
Forget the term "new paradigm" or the theory that new, young investors will keep the meme stocks supported; we heard the same false narratives back in 1999. Fundamentals always matter in the long run, and the correction to these money-burning companies will eventually arrive. Diamonds may be forged by fire and high pressure, but it will be entertaining to watch how "diamond hands" hold up when these two conditions come calling.
Economics: Work & Pay
03. Payroll growth hit the skids in August, coming up half-a-million jobs short
It's always thrilling to watch the monthly US Nonfarm Payrolls report roll in, as we never know what kind of surprises it has in store. Take August's figures, released by the US Labor Department Friday morning: Against economists' estimates for 720,000 new jobs, just 235,000 were created over the course of the month. That miss of nearly half-a-million jobs immediately sent the major indexes from positive to negative territory in the pre-market. The only thing that tempered investors' concern was the "bad news equals good news" phenomenon: they calculated that this report will force the Fed to hold off on any potential September tapering of the $120 billion per month T-bill/MBS spending spree. The Delta variant was, most believe, behind the anemic jobs growth for the month, but few believe we are heading back to lockdowns or other draconian measures. In other words, the business world is learning to adapt to a new era in which these variants are, sadly, always going to be around. Buttressing the Delta argument were the internals of the report, showing the biggest misses in industries directly affected by a pandemic resurgence, such as leisure and hospitality. On the bright side, the unemployment rate did drop 20 basis points, to 5.2%. The last time the US economy hit that number—on the way down, that is—was July of 2015.
We're not overly concerned about the August jobs report, as it truly does seem to be a direct result of the latest major variant of the disease. Infection rates and hospitalizations have generally peaked in the US and are coming back down, so we expect the robust hiring to pick back up through the remainder of the year. As the extra unemployment benefits fall off, more Americans will be incentivized into going back to work. The major push to create more in-home test kits and, more importantly, develop Covid therapies which can be administered at home should continue to mitigate the economic damage to the economy.
Capital Markets
02. Renaissance Capital: Get ready for a cascade of new IPOs this fall
If a new report issued by Renaissance Capital is correct, investors are going to have a dream autumn as the IPO market will see its busiest season since the peak of the Internet craze of 2000. Around 100 public offerings are expected to take place over the coming months, to include the likes of: Warby Parker, Allbirds, Authentic Brands (Nautica, Eddie Bauer), Impossible Foods, Chobani, Flipkart, Instacart, mobile payments processor Stripe, and social media darling Reddit. When the dust settles on 2021, Renaissance believes we will be looking back on 375 deals raising roughly $125 billion. There is no doubt the appetite is there, with new investors on the Robinhood platform willing to buy into companies not showing even a modicum of profits and, in a number of instances, scant revenue. As opposed to most of the names brought to market via the recent SPAC craze, however, we do like most of the companies anticipated to go public this fall. One, Warby Parker, will go the direct listing route due to its name recognition. While SPACs have been on a horrendous downturn throughout the summer due to their excessively-overpriced debuts (just because an IPO launches at $10 per share doesn't make it a good deal), expect some relatively reasonable valuations with this new crop. In fact, investors will be chasing so many new tickers that a few golden opportunities are bound to present themselves in a number of these new issues. Get ready for a whirlwind season.
Our advice? Prepare to make a few additions to the portfolio by looking at current sector weightings to identify underweight sectors and industries. Other than Stripe and Reddit, the names mentioned above are outside of the recent new-tech-stock craze. And that is a good thing.
Energy Commodities
01. As we head into sweater weather and beyond, beware the trajectory of natural gas prices
For anyone paying the family bills and living in a home which utilizes both gas and electric utilities, the cooler months generally meant a nice cost savings as the AC was turned off and the gas-powered heat came on. It always boggled our minds that homeowners would willingly go to an all-electric house, considering the spread between the price of the two commodities. That spread hasn't completely vanished, but the natural gas advantage is being rapidly diminished. In fact, the Henry Hub Natural Gas Spot Price has risen a remarkable 78%, from $2.43 to $4.33 per million British thermal units (MMBtu), just since this past April. A confluence of events have led to the dramatic price increase, from Europe's war on fossil fuels to an especially cold winter last year to a mysterious supply shortage in Russia. Whatever the mix of reasons, over which we have little to no control, expect higher gas bills this winter. Ironically, the spike in LNG prices has led to a semi-resurgence in the "dirtiest" of all fossil fuels, coal, as the price of the latter is substantially less than the former. Adding insult to injury is the fact that the hybrid work-from-home model means that families, not the companies they work for, will shoulder a higher percentage of the burden as they tap into more energy for their domestic work requirements.
Our pocketbooks may be hurting this winter, but the vilified fossil fuel producers have provided a nice opportunity for high-risk-tolerance investors. Cheniere Energy (LNG $89), a major exporter of liquified natural gas (no easy task, by the way), is up 50% ytd; while the hated coal company, Peabody Energy Corp (BTU $19), is up a whopping 670%. For a basket of LNG holdings, investors can consider the United States 12 Month Natural Gas ETF (UNL $12), the United States Natural Gas ETF (UNG $16), and the iPath Bloomberg Natural Gas ETN (GAZ $25).
Under the Radar Investment
Agnico Eagle Mines Ltd (AEM $57)
We have a strong thesis with respect to the current price of gold: it is undervalued. While the SPDR® Gold Shares ETF (GLD $168) is certainly one good method for playing the coming price increase of the precious metal, don't forget the gold miners as well. One of our perennial favorites—or at least a historical favorite when the price of gold has appeared undervalued—is Agnico Eagle Mines (AEM $57). The company is on pace to produce two million ounces of gold this year through its cornerstone mines in Canada, Mexico, and Finland. AEM is continually working to make its mining processes more efficient, reducing its all-in sustaining costs (AISC) by 10% this year, to $1,021 per ounce. The company believes it is on pace to reduce that figure to $950 per ounce in the very near future. The AISC is an industry-specific standard which portrays the true cost of mining an ounce of a given metal. With gold currently sitting at $1,789 per ounce, AEM shares are sitting near their 52-week low. With a market cap of $14B, the company has an eighteen multiple and a solid balance sheet (L/T assets/liabilities=$8.6B/$3.35B). Conservatively, we place AEM's fair value at $75/share, or 32% above where they currently trade.
Answer
The Battle of Saratoga consisted of two crucial battles, eighteen days apart. The Battle of Freeman's Farm, which took place 19 September 1777 on the abandoned farm of loyalist John Freeman, ended up being a pyrrhic victory for General John Burgoyne, as the British forced the Americans to retreat, but lost twice as many men in the process. This prevented the British from continuing their drive to Albany. Then, on 17 October 1777, two American officers, Major General Benedict Arnold and Brigadier General Daniel Morgan, fought savagely to deal Burgoyne a humiliating defeat. Their commanding officer, Major General Horatio "Granny" Gates, took credit for the victory, despite remaining safely in his tent during the battle and excoriating Arnold for his "reckless" actions. This incident, among others, would ultimately push Benedict Arnold, whose leg was severely mangled during the fighting, to become a traitor to the cause and a spy for the British.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Turning point of the American Revolution...
Despite Washington's impressive Revolutionary War victory against the German Hessians on December 26th, 1776 in the town of Trenton, there wasn't much to celebrate during the brutal months to come. What stunning victory began to turn the tide in favor of the Americans and convinced the French to join the fight against their longstanding nemesis, Great Britain?
Penn Trading Desk:
Penn: Changes to mining companies within the Global Leaders Club
After performing a review of the Metals & Mining industry, we are removing the two gold miners currently in the Penn Global Leaders Club and replacing them with an alternate name. Instead of an outright sell order, we recommend placing stops on the current positions slightly below their current respective prices. Members, see the Trading Desk for specific instructions. As always, clients of Penn Wealth Management, our Registered Investment Advisory service and a separate entity, will automatically have these actions taken.
JP Morgan: Add Sunrun to "U.S. Analyst Focus List"
JP Morgan just added $10 billion solar energy and storage company Sunrun (RUN $47) to its highest conviction group of names, the U.S. Analyst Focus List. Analyst Mark Strouse likes the fundamentals for the industry over the medium and long term, and believes supply constraints will ease in the second half of the year. While the risk, as measured by beta, is a quite large 2.089, the median target share price among analysts covering the stock is $76.53, or 62% higher from here. We listed some of our favorite clean energy plays in a recent Penn Wealth Report.
Cowen: Raise rating and price target on Textron
Citing a strong comeback in the demand for business jets and the nascent civilian VTOL (vertical take-off and landing) movement, Cowen has raised its rating on aviation firm Textron from Market Perform to Outperform, and has adjusted its target price for TXT shares from $75 to $95. That is a street high, with Morningstar taking the opposite side of the bet with its one-star rating and $42 per share target price. The average price target among the eleven analysts weighing in on the Rhode Island-based firm is $78 per share.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. In a refreshing twist, Coinbase's CEO fires back at SEC
We are ambivalent with respect to cryptos: their future as a means of exchange feels certain, but the industry is going through its Wild West phase right now, with plenty of risks and opportunities for investors. We are equally ambivalent about the SEC (and most other government agencies as well): they enforce needed guardrails, yet they too often create more problems than they resolve. Which leads to the brouhaha going on right now between the SEC and Coinbase (COIN $257), the leading crypto exchange platform in the United States and a current member of the Penn Intrepid Trading Platform. Shares of the exchange fell sharply this week as the SEC warned that it planned to sue if the company forged ahead with plans to allow its users—of which it currently boasts some 68 million—to earn interest by lending crypto assets. Apparently the SEC believes that privilege should rest solely in the hands of the banks. It is crystal clear that current SEC Chairman Gary Gensler plans on doing battle with a host of financial services companies during his reign, with cryptos, perhaps, being his number one target.
When a company receives a Wells Notice, a formal notice from the SEC informing the recipient that the agency is preparing enforcement actions, it is traditional to stay relatively mum; certainly not to stir the pot. Apparently, Coinbase CEO Brian Armstrong is taking a page from Elon Musk's playbook, as he remained anything but mum following the announcement. In what Bloomberg described as "a rant" and "a fit" (it was neither, Bloomberg), Armstrong unloaded on the commission. In one tweet, the dynamic CEO noted "Some really sketchy behavior coming out of the SEC recently. Story time...." Ironically, it was Coinbase's willingness to share its plans for the new lending platform with the SEC—instead of pushing ahead and implementing the plan—which instigated the threats from the government body. Instead of a few polite questions to delve further into how the process would work, the SEC, i.e. Gensler, took the very public action of issuing the Wells Notice. Not cool, SEC. Jesse Powell, co-founder of the crypto exchange Kraken, came to Armstrong's defense in his own series of tweets: "We won't tell you why we think your product is illegal but we will tell you that there is no path to making it legal. Disagree? Go ahead and see what happens." CEOs daring to fight back against government regulators? Brilliant! While the zeitgeist seems to consist of corporate heads cowardly genuflecting to any and all social movements looking their way, it is refreshing to see a little gutsy pushback against the tactics of bullies. That used to be called The American Spirit.
Despite the SEC-caused downturn in the stock, our COIN position is still up 10% since purchase. We fully expect the firm to weather this storm. We doubt the SEC fully understands how the crypto exchanges even work, so it will buy some time while the government attorneys attempt to get up to speed. After that, let the lengthy court battles begin.
Beverages & Tobacco
09. Tilray's convoluted effort to get its foot in the door of the US cannabis market
We have mentioned before our deep respect for Irwin Simon, founder of Hain Celestial (HAIN $40) and current CEO of Canadian cannabis company Tilray (TLRY $14). That being said, we do not currently own any specific cannabis names within any of the Penn portfolios. It's not that we don't believe in the future of the industry from an investment standpoint; we are simply waiting for the winners to break free from the inevitable losers. We expect Tilray to be a long-term player, but it doesn't yet have the ability to crack the lucrative US market. The company is trying to change that. As a Canadian cannabis company dual listed on the Toronto Exchange and the Nasdaq, the fact that cannabis is still illegal in the US at the federal level precludes Tilray from setting up operations south of their current border. So, in a complex, circuitous route, management just made a very interesting move. They acquired around $170 million of convertible MedMen (MMNFF $0.29) debt through a new limited partnership, with the debt's maturity date being extended out through August of 2028. MedMen is the preeminent cannabis player in the US, with access to roughly 50% of the total addressable (legal) market. The firm has major operations in California, Nevada, and New York. What does this mean for Tilray? The company's CEO made it pretty clear in recent comments: he believes that his Canadian entity will be able to acquire control of MedMen once cannabis is legalized at the federal level. Acquiring $170 million in debt for a micro-cap player in the US may not seem that big of a deal, but we fully expect the adroit Simon to leverage it into a major piece of the action as the domestic market for cannabis expands.
While we have played with positions in Tilray as well as Canopy Growth Corp (CGC $18), another major Canadian player, we have yet to add a cannabis company to a portfolio. MedMen may look attractive to some investors, but its current $0.29 share price represents a dramatic fall from the high of $1.47 it hit in February of this year. All of these firms remain huge money losers, though the space is worth keeping an eye on.
Aerospace & Defense
08. The last major aviation market refusing to lift ban on 737 MAX should come as no surprise
We have certainly given aircraft maker Boeing (BA $218) a lot of grief over the past two years, but this is a story more about politics than aviation prowess. Most other major aviation markets lifted the ban on the Boeing 737 MAX late last year or early in 2021, with two notable exceptions: India and China. This week, India's Directorate General of Civil Aviation announced that the model has received the green light to resume operations in that country, leaving only China's ban in place. Boeing's management team clearly believes the Chinese market is crucial for the company's growth story going forward, with one-fifth of the firm's aircraft deliveries since 2017 heading to the communist nation. But the trade war, the pandemic, and China's own economic ambitions have strongly constricted sales, leaving primarily Airbus (EADSY $34) to pick up the slack. China wants that situation to change as well, touting its own manufacturer, the Commercial Aircraft Corporation of China, or Comac. The company's nascent efforts, the ARJ21 and the C919—the latter of which it hopes can go head to head with the 737 MAX and the Airbus A320, have been riddled with defects and delays. The problems have kept would-be buyers at bay, despite the C919 selling for about half as much ($50 million) as the Airbus A320neo. Nonetheless, China, through its Belt and Road infrastructure initiative, will pump as much money as needed into Comac until it shows signs of life. As for the MAX, China would love to have Comac's C919 step in to fill the void, but it is unlikely that will happen anytime soon. Expect a lift on the ban to come—out of pure necessity—by the end of the year.
Boeing is facing a host of serious problems; a new competitor in the form of a state-sponsored Chinese aircraft manufacturer is one we haven't even touched on before. CEO David Calhoun is actively pushing the Biden administration to urge China to lift its ban on the MAX, but what really needs to be taking place is more activism in the ranks of BA shareholders to force an overhaul of Boeing's board of directors—including its president and CEO—Calhoun.
Demographics & Lifestyle
07. China limits videogame usage to three hours per week for minors, no play Monday through Thursday
Our first thought was, "Imagine trying to implement such a law in the U.S." China, as part of its latest salvo against industries it deems harmful to the collective cause, has issued a rather remarkable decree: minors—we are assuming that means youth under the age of eighteen—are hereby forbidden from playing videogames Monday through Thursday, and will limit their play to a maximum of one hour per day on Fridays, weekends, and public holidays, between the hours of 8 p.m. and 9 p.m. The ruling communist party claims that the "youth videogame addiction" is distracting young people from their responsibilities to school and family. How on earth does the government plan on enforcing this new dictate? Since the government controls the tech companies which operate in China, and these companies can control users via login credentials, the task isn't as herculean as it may seem. Just how granular is the government willing to get with respect to controlling its population? A few years back, videogame players between the ages of 16 and 18 were told that they could not spend over 400 yuan (about $60) per month on the purchase of new games.
At first blush, we imagine many Americans applaud such a move to restrict the brain-numbing play of videogames by a country's youth. However, a government which can and will control such a mundane aspect of life will never reach a level of satisfaction; lines in the sand will be just that, and they will be redrawn at the whim of the ruling members of the party. Personal freedoms will continue to wither away until an inevitable clash occurs between the masses being controlled and the elites who are imposing the draconian standards. China believes it can simultaneously control and feast off of the golden goose of economic prosperity. That faulty logic stems from the incredible level of arrogance and hubris which communism foments among its ruling class. The short-term pain we so often experience in a democracy is allowed to mushroom out of control within a closed society. Despite the lessons of the past, this is a condition lost on many within the financial media; journalists who eagerly regurgitate what the state-controlled media in China feeds them. As for the Chinese Internet companies which so many investors have been wantonly rushing into, many are now sitting 50% below their February highs on the heels of this latest government crackdown.
Application & Systems Software
06. Skittish investors drive Zoom Video shares down 25% in August
It is hard to believe, but it was just one year ago that investors were betting the farm on the future of Zoom Video Communications (ZM $289), driving shares up to astronomical valuations. After all, the company just happened to offer the exact right services at precisely the right time: a way for teachers to connect with students and for management to collaborate with workers in a world where schools and offices had been shut down due to the pandemic. It's not as though the company won't continue to excel, or that the health threat is behind us; it's more a case of investors' euphoria giving way to the reality of kids and workers going back to their respective schools and offices. Tuesday accounted for the second-largest one-day drop in Zoom's short history, with shares falling 17%, but August has been particularly brutal as the company lost about one-quarter of its market cap. But was it ever really deserving of the $160 billion market cap it held in October of last year, and does $86 billion signal a golden buying opportunity? The answer to both questions is, in our opinion, "no." Putting its size in perspective, ZM is nestled between banking stalwart US Bancorp (USB) and aerospace giant Lockheed Martin (LMT). That's hard to justify; but, then again, it makes more sense that AMC Entertainment (AMC) having a $24 billion market cap. (The latter was a $450 million company teetering on the brink of bankruptcy going into this year.)
Ironically, Zoom's big drop came after the company reported revenue of over $1 billion in the second quarter of the year, handily topping estimates. That figure represents a 54% gain over the same quarter last year, and a 700% gain over the same quarter in 2019. It was the guidance, however, that spooked investors. Subscribers are dropping off at an unexpected rate, and management warned that revenues would probably remain flat through the end of the year. Even after the August drop, Zoom's P/E ratio is still a lofty 100, but at least it has a multiple—unlike AMC.
We have a lot of respect for Zoom and its management team, and the company's long-term viability is not in question. However, there are so many other massive competitors getting into the space—from Microsoft to Google to Cisco—that it will be a street fight going forward. As the firm rolls out new services, such as Zoom Phone, it will grow into its multiple, but that would indicate it is rather fairly valued right around where it sits today.
Capital Markets
05. Robinhood investors should be concerned about recent comments made by the new SEC chairman
I recall would-be clients, early in my career, telling me that "we own American Century no-load mutual funds, so we don't pay any fees." My retort was always the same: "I wonder how they paid for those two beautiful towers where their headquarters is located, or how they pay their staff?" In reality, despite the flowery ads designed to make us think that a company's sole existence is to help others, it's always about the money. I thought of those comments, made to me in the late 1990s, as I read about the latest threat to newly-public Robinhood Markets (HOOD $44). As the financial services platform offers customers commission-free trading, where does the revenue come from? Overwhelmingly, the answer lies in something called payments for order flow (PFOF).
When a customer wishes to buy or sell shares of a company or to trade options, the broker—be it Robinhood, Schwab, or a host of others—forwards the trade to a market maker. Historically, these intermediaries were at the major exchanges, such as the New York Stock Exchange. More recently, however, a slew of off-exchange market makers have popped up and are now responsible for over half of all retail trades placed. They make their money off of the difference between what they pay to buy the requested shares and what they sell them for seconds later—the spread. Understandably, the higher the volume of orders flowing through a market maker, the more profit to be made. Since companies like Robinhood can choose who handles a given trade, these third-party market makers have been offering to share a percentage of the spread with the brokers; hence, payments for order flow. In one month alone, Robinhood reportedly generated $100 million in revenue via this practice.
Many of the larger brokerages, such as Fidelity and Interactive Brokers, generally refuse to accept PFOF. In fact, countries like Canada, Australia, and the U.K. have gone so far as to ban the practice altogether. Enter SEC Chairman Gary Gensler. In a Barron's interview, Gensler said that a ban on PFOF is "on the table." Transparency seems to be the term du jour in the financial services world, which means an ultimate U.S. ban is quite possible. For Robinhood, which makes a majority of its revenue from PFOF, this would be a disastrous course of events.
With HOOD shares trading nearly 50% off of their August high of $85, investors might be tempted to jump in. We are sticking by our previous comments, however, and would wait to see a price in the mid-$20s range before considering a new stake.
Media & Entertainment
04. Joke of the Week: GameStop headed back to the S&P 500?
It doesn't take much news, if any, to make a meme stock gyrate wildly in price, but the reason behind the most recent leg up in shares of GameStop (GME $214) is rather humorous. It seems a rumor began circulating that the reddit darling may be headed back to the S&P 500, the index which gave the company the boot back in 2016 due to deteriorating fundamentals. Granted, five years ago the videogame consumer retailer had dropped in size to $2.5 billion (it is now comically valued at $15 billion), but it was also generating over $9 billion in revenue and was operating in the black. Now, the company's sales are about half that amount and it hasn't turned a profit in over three years. That in itself should keep it out of the index, which requires an entrant to have positive earnings for not only the most recent quarter (GME lost $67 million), but also for the most recent four quarters in aggregate (GME lost $116 million TTM). Membership into the S&P 500 is not a matter of quant calculations; ultimately, an index committee made up of staffers at S&P Dow Jones Indices decide a company's fate. Bloggers and reddit users can speculate all they want, generally driving the price up as they do, but the odds of seeing ticker GME in the S&P 500 ever again are slim to none.
Forget the term "new paradigm" or the theory that new, young investors will keep the meme stocks supported; we heard the same false narratives back in 1999. Fundamentals always matter in the long run, and the correction to these money-burning companies will eventually arrive. Diamonds may be forged by fire and high pressure, but it will be entertaining to watch how "diamond hands" hold up when these two conditions come calling.
Economics: Work & Pay
03. Payroll growth hit the skids in August, coming up half-a-million jobs short
It's always thrilling to watch the monthly US Nonfarm Payrolls report roll in, as we never know what kind of surprises it has in store. Take August's figures, released by the US Labor Department Friday morning: Against economists' estimates for 720,000 new jobs, just 235,000 were created over the course of the month. That miss of nearly half-a-million jobs immediately sent the major indexes from positive to negative territory in the pre-market. The only thing that tempered investors' concern was the "bad news equals good news" phenomenon: they calculated that this report will force the Fed to hold off on any potential September tapering of the $120 billion per month T-bill/MBS spending spree. The Delta variant was, most believe, behind the anemic jobs growth for the month, but few believe we are heading back to lockdowns or other draconian measures. In other words, the business world is learning to adapt to a new era in which these variants are, sadly, always going to be around. Buttressing the Delta argument were the internals of the report, showing the biggest misses in industries directly affected by a pandemic resurgence, such as leisure and hospitality. On the bright side, the unemployment rate did drop 20 basis points, to 5.2%. The last time the US economy hit that number—on the way down, that is—was July of 2015.
We're not overly concerned about the August jobs report, as it truly does seem to be a direct result of the latest major variant of the disease. Infection rates and hospitalizations have generally peaked in the US and are coming back down, so we expect the robust hiring to pick back up through the remainder of the year. As the extra unemployment benefits fall off, more Americans will be incentivized into going back to work. The major push to create more in-home test kits and, more importantly, develop Covid therapies which can be administered at home should continue to mitigate the economic damage to the economy.
Capital Markets
02. Renaissance Capital: Get ready for a cascade of new IPOs this fall
If a new report issued by Renaissance Capital is correct, investors are going to have a dream autumn as the IPO market will see its busiest season since the peak of the Internet craze of 2000. Around 100 public offerings are expected to take place over the coming months, to include the likes of: Warby Parker, Allbirds, Authentic Brands (Nautica, Eddie Bauer), Impossible Foods, Chobani, Flipkart, Instacart, mobile payments processor Stripe, and social media darling Reddit. When the dust settles on 2021, Renaissance believes we will be looking back on 375 deals raising roughly $125 billion. There is no doubt the appetite is there, with new investors on the Robinhood platform willing to buy into companies not showing even a modicum of profits and, in a number of instances, scant revenue. As opposed to most of the names brought to market via the recent SPAC craze, however, we do like most of the companies anticipated to go public this fall. One, Warby Parker, will go the direct listing route due to its name recognition. While SPACs have been on a horrendous downturn throughout the summer due to their excessively-overpriced debuts (just because an IPO launches at $10 per share doesn't make it a good deal), expect some relatively reasonable valuations with this new crop. In fact, investors will be chasing so many new tickers that a few golden opportunities are bound to present themselves in a number of these new issues. Get ready for a whirlwind season.
Our advice? Prepare to make a few additions to the portfolio by looking at current sector weightings to identify underweight sectors and industries. Other than Stripe and Reddit, the names mentioned above are outside of the recent new-tech-stock craze. And that is a good thing.
Energy Commodities
01. As we head into sweater weather and beyond, beware the trajectory of natural gas prices
For anyone paying the family bills and living in a home which utilizes both gas and electric utilities, the cooler months generally meant a nice cost savings as the AC was turned off and the gas-powered heat came on. It always boggled our minds that homeowners would willingly go to an all-electric house, considering the spread between the price of the two commodities. That spread hasn't completely vanished, but the natural gas advantage is being rapidly diminished. In fact, the Henry Hub Natural Gas Spot Price has risen a remarkable 78%, from $2.43 to $4.33 per million British thermal units (MMBtu), just since this past April. A confluence of events have led to the dramatic price increase, from Europe's war on fossil fuels to an especially cold winter last year to a mysterious supply shortage in Russia. Whatever the mix of reasons, over which we have little to no control, expect higher gas bills this winter. Ironically, the spike in LNG prices has led to a semi-resurgence in the "dirtiest" of all fossil fuels, coal, as the price of the latter is substantially less than the former. Adding insult to injury is the fact that the hybrid work-from-home model means that families, not the companies they work for, will shoulder a higher percentage of the burden as they tap into more energy for their domestic work requirements.
Our pocketbooks may be hurting this winter, but the vilified fossil fuel producers have provided a nice opportunity for high-risk-tolerance investors. Cheniere Energy (LNG $89), a major exporter of liquified natural gas (no easy task, by the way), is up 50% ytd; while the hated coal company, Peabody Energy Corp (BTU $19), is up a whopping 670%. For a basket of LNG holdings, investors can consider the United States 12 Month Natural Gas ETF (UNL $12), the United States Natural Gas ETF (UNG $16), and the iPath Bloomberg Natural Gas ETN (GAZ $25).
Under the Radar Investment
Agnico Eagle Mines Ltd (AEM $57)
We have a strong thesis with respect to the current price of gold: it is undervalued. While the SPDR® Gold Shares ETF (GLD $168) is certainly one good method for playing the coming price increase of the precious metal, don't forget the gold miners as well. One of our perennial favorites—or at least a historical favorite when the price of gold has appeared undervalued—is Agnico Eagle Mines (AEM $57). The company is on pace to produce two million ounces of gold this year through its cornerstone mines in Canada, Mexico, and Finland. AEM is continually working to make its mining processes more efficient, reducing its all-in sustaining costs (AISC) by 10% this year, to $1,021 per ounce. The company believes it is on pace to reduce that figure to $950 per ounce in the very near future. The AISC is an industry-specific standard which portrays the true cost of mining an ounce of a given metal. With gold currently sitting at $1,789 per ounce, AEM shares are sitting near their 52-week low. With a market cap of $14B, the company has an eighteen multiple and a solid balance sheet (L/T assets/liabilities=$8.6B/$3.35B). Conservatively, we place AEM's fair value at $75/share, or 32% above where they currently trade.
Answer
The Battle of Saratoga consisted of two crucial battles, eighteen days apart. The Battle of Freeman's Farm, which took place 19 September 1777 on the abandoned farm of loyalist John Freeman, ended up being a pyrrhic victory for General John Burgoyne, as the British forced the Americans to retreat, but lost twice as many men in the process. This prevented the British from continuing their drive to Albany. Then, on 17 October 1777, two American officers, Major General Benedict Arnold and Brigadier General Daniel Morgan, fought savagely to deal Burgoyne a humiliating defeat. Their commanding officer, Major General Horatio "Granny" Gates, took credit for the victory, despite remaining safely in his tent during the battle and excoriating Arnold for his "reckless" actions. This incident, among others, would ultimately push Benedict Arnold, whose leg was severely mangled during the fighting, to become a traitor to the cause and a spy for the British.
Headlines for the Week of 01 Aug—07 Aug 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The communist party declares open season on domestic Internet companies...
Since February, when China began ramping up its attack on Net-based companies under its domain, the affected stocks have been plummeting. Since that time, what percentage have they, as a group, dropped in price?
Penn Trading Desk:
Penn: Purchased a play on the surging demand for outdoor recreational activities
Americans want to get out and explore their country to an extent not seen in a century. We added an undervalued name to the Intrepid Trading Platform which is well poised to take advantage of this trend, and one which happens to be on an aggressive acquisition spree to increase its breadth in the arena.
Penn: Placing a stop loss to protect our American Campus Communities gains
We purchased student housing REIT American Campus Communities right as analysts were predicting a dire situation for students returning to their respective colleges in the fall of 2020. We never bought into the "mass closings of dormitories" thesis and saw a great opportunity in the shares. In addition to strong growth potential, we were drawn to the company's 5.41% dividend yield. ACC has blown past our $40 initial price target and we are protecting our gains with a $47 stop loss on the shares.
Penn: Placing a stop loss to protect our MGM gains
We added the Las Vegas Strip's largest resort casino operator, MGM Resorts International, to the Penn Global Leaders Club last year as the industry was reeling from the pandemic. MGM shares surpassed our target price, are now up 130% from our purchase price, and have been falling back recently due to the Delta variant. We still believe in the company's long-term vision, but are not willing to fall below a triple-digit gain. We have placed a stop on the shares at $34, or $2 above our target price.
Penn: Placing a stop loss to protect our AVB gains
We opened our position in AvalonBay Communities (AVB $227) within the Strategic Income Portfolio in July of 2020, and this owner of 275 apartment communities—with 74,000 units—has seen its share price rise well above our initial price target of $182. Valuations seem a bit stretched, and with the share price hovering near an all-time high, we are putting protection on our position with a $218 stop loss.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Use diligence before clicking on that "unsubscribe" button at the bottom of spam emails
Remember when it was actually fun to find new emails waiting to be opened in your inbox? A few of us even remember AOL's iconic "you've got mail" notification. How times have changed. Americans are now inundated with mountains of new emails each and every day, and trying to cull the weeds from the garden can be challenging, to say the least. Instead of just whacking away by deleting them, knowing they are destined to return, many of us have tried to eradicate them using the mandatory (at least we thought it was) "Unsubscribe" button located in microscopic print somewhere near the bottom of each piece. We recently began to wonder, though, if the sage advice of not clicking on any link we're not extremely familiar with also held true for this innocuous little "opt out" key.
In fact, it turns out that malicious emails can, indeed, have unsubscribe links that lead to dangerous sites which can compromise or even infect your system with a virus. According to cybersecurity firm McAfee, following a few simple rules can help keep your system—and the treasure trove of data it probably holds—safe(r) from the dark web. If the email is from a legitimate company with which you are familiar, it should be safe to take a minute of your valuable time and go through the unsubscribe process. (Most are simple, others are purposefully irritating, making you put in the email address where they sent their junk!) If the email is from a company you don't recognize or one that seems a bit fishy, do not hit the unsubscribe link, just delete the email. For nefarious individuals and the algorithms they devise, this verifies that they have made a successful hit on a "validated" email address. If this is the case, the best scenario is more unwanted email heading your way. An uglier possibility is that the simple act of clicking on an unsubscribe button or link can lead to a virus being downloaded to your system. Another reason it pays to have good antivirus software protecting your system at all times.
Bottom line: simply delete or move to spam/junk any email that appears suspicious. In addition to having a strong web protection system installed on all of your devices, be sure and have it run scans on your system on a regular basis. Always keep your operating system up-to-date as well, as new malicious efforts are constantly being identified by software developers.
Beverages & Tobacco
09. Boston Beer's big bet on seltzer hits a wall, shares plummet
Boston Beer (SAM $716), maker of Sam Adams, has been our favorite name in booze/brewers for a number of years. Fiercely independent (as opposed to the big three, which are all now owned by foreign entities), the company simply makes an excellent product and has an exemplary management team, led by founder and Chairman of the Board Jim Koch. The sheen began to come off the name, however, when SAM started pushing a mediocre beer called Sam 76. That misstep was followed by another: the company bet big on hard seltzers—the modern version of Zima or Bartles & Jaymes wine coolers—at the expense (in our opinion) of their staple beer business. Hopefully they received the message investors sent them last week. After missing Q2 earnings badly ($4.75/sh vs the $6.60/sh expected), management admitted to increasing production of Truly hard seltzer to meet a summer demand which never fully manifested. For the quarter, SAM generated $602.8M in revenue versus expectations for $675.7M. To make matters worse, the firm cut its guidance for the remainder of the year. All of this was enough to pound SAM shares down 26% in one day and 31% from the week's peak to trough price.
We haven't owned SAM shares within the Penn portfolios since our disappointment over the capital expended on the ill-fated Sam 76 campaign, and the hard push into hard seltzers only reinforced our decision. Even if the company does pivot back to its staple, high-end beer business, the field is now crowded with new competitors. Analysts seem to be gravitating toward an average price target of $1,000, but we are waiting to see evidence that management fully understands the problem and is willing to make a mea culpa on their recent moves.
Automotive
08. Tesla earned over $1 billion this past quarter, ten times more than it made in the second quarter of 2020
EV maker Tesla (TSLA $658) just achieved its eighth-straight quarter with positive cash flow, earning $1.14 billion in profit between April and June. As if that wasn't impressive enough, the figure represents a ten-fold increase over the $104 million it earned in the same quarter last year. Revenue in Q2 doubled from last year, from $6.04 billion to $11.96 billion. It is difficult to find any flaws in the earnings report, but that didn't stop the chronic naysayers from pointing out why this level of growth is unsustainable. Those comments are rather ironic, considering the company had to weather recalls, a backlash from Chinese consumers, and a chip shortage over the course of the quarter. As for Musk, he hinted that this may be the last earnings conference call he would be taking part in, let alone leading. We can fully understand that decision.
Too many analysts continue to view Tesla as just another car company. Granted, were that the case, the multiples for the company are excessively high. We don't buy the premise, however. Tesla earned nearly $1 billion from its energy business last quarter, installing 60% more energy storage systems in homes than it did the previous quarter. Furthermore, we are most excited about the FSD (full self-driving) subscription service that should mushroom after future system upgrades make the company's vehicles fully autonomous. Then there is the company's advanced battery production facilities and its benchmark Supercharger DC fast-charting stations, which it will soon open to non-Tesla vehicles. We believe the Tesla growth story remains fully intact.
Global Exchanges & Indexes
07. The high risks associated with investing in Chinese tech companies
There have always been outsized risks associated with investing in Internet companies; when those companies happen to be based out of Communist China, those risks are compounded. For evidence, consider the popular KraneShares CSI China Internet ETF (KWEB $52). This fund holds fifty of the largest Chinese Internet companies listed on exchanges outside of Mainland China (presumably to mitigate risk). Alibaba and Tencent Holdings are the two largest positions within the fund. On 17 February, shares of KWEB hit $104.94; now, just five months later, they have been sliced precisely in half. Put another way, a $10,000 investment in the fund five months ago would now be worth $5,000.
China's general crackdown on publicly-traded companies and the more recent rules handed down to rein in for-profit education companies—such as the $4 billion New Oriental Education & Technology Group (EDU $2)—have been the major catalyst for the plummet. EDU has been a popular bet for investors looking to ring up profits in Chinese companies, with the shares jumping from $5 in 2019 to a peak of $20 this past February, before settling back down to their current $2 range. Why would China, which is bent on becoming the world's largest economy in short order, create a host of new rules designed to stifle the growth of their own companies? Note that KWEB focuses on shares of companies listed outside of the country; China wants to promote those listing on domestic exchanges—the largest being the Shanghai Stock Exchange. These rules are a shot across the bow to home-grown companies daring to list outside of the country. As has always been the case, investors are at the mercy of the all-powerful Chinese Communist Party.
There are so many wonderful opportunities right now across the globe, both in frontier/emerging and developed markets, that we urge investors to focus on areas which promote democratic values and offer citizens a high level of personal freedom. We don't believe it is worth the risk to have direct exposure to individual Chinese companies. The KWEB example shows how much risk is involved even in owning a basket of the largest publicly-traded companies based out of Mainland China.
Aerospace & Defense
06. Brain drain at Boeing: engineers and technicians are leaving the firm at an alarming rate
Bloomberg recently published an interesting and rather in-depth story on the flight of disillusioned engineers and technicians out of the exits at Boeing (BA $233). Certainly, the dual tragedies of recent 737 MAX crashes have impacted morale at the firm, but the problem has more to do with a management team wandering aimlessly in search of a strategic mission than it does with any specific events. When a former Boeing CEO announced, "no more 'moon shots,' it might as well have become the new company slogan. For young engineers, the excitement which once swirled around working for the world's largest aerospace and defense company has been replaced by, "well, at least it will look good on my résumé." Those workers have been taking their résumés to competing firms in droves as of late. And the recipients of this talent pool are not just the usual suspects such as SpaceX, Blue Origin, and Virgin Galactic.
Since the beginning of last year, over 3,200 engineers and technicians have bolted from the firm—a figure which accounts for nearly one-fifth of the 18,000 Boeing workers represented by the Society of Professional Engineering Employees in Aerospace (SPEEA) union. While many have been attracted to SpaceX's stunning recent successes and Elon Musk's bold vision for the future of humanity in space, Amazon has also been a major destination for these skilled workers. The idea of remaining in the Seattle area with a nice pay bump has been the major selling point for the latter. Amazon employs these specialists to increase the efficiency at their warehouses, much like they did with the Boeing factory floors.
The airliner catastrophes and a lack of a new generation passenger aircraft on the drawing boards at Boeing have not been the only forces driving workers away. On the space side of the equation, the company's recent Starliner failures stand in stark comparison to the stunning SpaceX successes. The company will have another chance to prove itself with the upcoming crew capsule test slated for this weekend, but even with a glaring success the firm has a long way to go. Meanwhile, European nemesis Airbus is increasingly outpacing Boeing with respect to both orders and deliveries. In the first quarter of 2021, Boeing delivered 77 aircraft versus 125 jets for Airbus—a 62% differential. By the end of Q1, Airbus reported a backlog of nearly 6,000 jets, while Boeing's backlog amounted to just shy of 5,000 aircraft. Furthermore, with no exciting new designs to show potential buyers, we are not sure what will be the catalyst for a comeback.
In our opinion, there is a horrendous vacuum leadership at Boeing, and the company's great turnaround cannot occur until a nearly clean sweep is made at the top. Unfortunately, the entire leadership team would disagree with that assessment. It will take major activist investor push to force the change required, but there hasn't been much action on that front either. At least we have SpaceX around to spearhead America's great return to manned spaceflight.
Media & Entertainment
05. Scarlett Johansson sues Disney over streaming release of Black Widow, Disney fires back with scathing retort
Our immediate thought was, "poor Scarlett, $20 million for one movie wasn't enough?" However, the more we delved into the story, the more it appears this will be one heck of a court battle. Actor Scarlett Johansson, number seven on the list of IMDb's hottest female actors of 2021, is suing Disney (DIS $ 176) for simultaneously releasing Black Widow, in which she plays the eponymous lead role, in theaters and on the Disney+ streaming service for a fee. Johansson's beef is this: the better the movie does at the box office, the more she will stand to make for her role. According to her attorney, the streaming release was done primarily for Disney to add subscribers, and a large number of viewers decided to forego the theater and stream instead. The figures show that Disney did, indeed, fatten its wallet by charging $30 for Disney+ members to stream the movie. Over the course of its opening weekend, Black Widow raked in $80 million at the US box office, $78 million at the worldwide box office, and a whopping $60 million from its Disney+ platform.
Disney shot back directly at Johansson, saying that "the lawsuit is especially sad and distressing in its callous disregard for the horrific and prolonged global effects of the COVID-19 pandemic." Yes, Disney, we are sure you released the movie on your streaming service as a public service, which is why you charged paying subscribers an additional $30 a pop. Actually, the more we mull the situation over, the more we tend to side with Johansson. Based on other movies released during the pandemic and the way in which other studios compensated their talent, she probably would have made around $25 million more for the movie than she did. In addition to a probable loss in the courts, Disney will suffer a real black eye in Hollywood over this one.
When Bob Chapek took over at Disney, we cashed out—despite having owned the company in the Penn Global Leaders Club for years. It appears we made the right call. Nothing matters like management.
Capital Markets
04. HOOD's wild ride: platform for the meme stocks turns into one itself
By most accounts, it was a lackluster debut. The much-anticipated IPO of financial services platform Robinhood (HOOD $55) finally occurred last week, but shares ended up tumbling 12% from their $38 initial offering price almost immediately. Considering the platform boasts some 20 million accounts, one would have expected fireworks out of the gate, akin to an Airbnb ($145) or a DoorDash (DASH $176). But, alas, the WallStreetBets/reddit monster ended up harming the very company which fomented the movement, with some on the social media sites even calling on members to short the stock on day one. That is rich, considering users' raison d'être seemed to be destroying the shorts. ARK Investment's Cathie Wood, someone whom we respect a lot, may have played a part in the turnaround which occurred after day one by buying 1.85 million shares below the IPO price. Despite Wood's buy, we tend to agree with Morningstar's fair value of $30 on the shares, meaning they have some additional falling to do before we are interested.
When the reckoning does hit the markets, and it will, expect HOOD to get pounded. The world where an AMC, which is worth $5 per share, trades at $38 per share will eventually come crumbling down, and some semblance of sanity will return. At that point, there will be a lot of formerly-overvalued stocks worth picking up, and plenty we still wouldn't touch. As for HOOD, if the $30 fair value is accurate that means $25 per share might be a good point to jump in.
Automotive
03. We called it: Nikola's founder, Trevor Milton indicted on fraud charges
We have been calling EV maker Nikola (NKLA $11) little short of a sham for a couple of years now. Our opinion was cemented after we saw the company's founder, Trevor Milton, in several interviews. Based on decades of CEO-watching, we got a really bad feeling about the founder and his alleged product lineup. While the company was spared in the indictment, the US government has just charged the founder with three counts of fraud, stating that he lied to investors "about nearly all aspects of the business." We may have had a bad feeling about the firm, but investors certainly didn't: NKLA shares went from $10 in March of 2020 to $80 three months later, since dropping back to the $12 range. While at their high, Milton had a paper net worth of roughly $9 billion; that figure is now floating around $1 billion, but we imagine there is plenty more pain ahead. The wheels became to come off the cart last September after Hindenburg Research published a scathing article on the EV firm, pretty much echoing the government case—or vice versa. Shortly after the report was released, Milton was out at the firm he started and a deal the company cobbled together with General Motors fell apart (we excoriated GM when it made the deal). If we want to ignore the company's financials (basically zero revenue) and focus on production, try this on for size: the company has produced zero vehicles for public sale.
Tesla was enormously successful, so we should just jump into an EV maker that sounds like the next Tesla, right? Heck, this company even took the famous inventor's first name! Madness. It is understandable that the financials wouldn't look stellar on a nascent company trying to break into an industry with a pretty tall barrier to entry, but we are talking about a company that went public without having one vehicle roll off of an assembly line. NKLA may not have been a meme stock, but the same level of (ir)rational thought went into the purchase of the shares.
Industrial Conglomerates
02. A sure sign of desperation: financial engineering has replaced cutting-edge engineering at General Electric
I feel bad for General Electric (GE $105); embarrassed for this once-great American powerhouse. Has Edison's firm really been reduced to this? Some companies have a "move fast and break things" mentality. GE's grand strategic vision is "let's do a reverse stock split at just the right level to move our share price into triple digits like our competition." I mean, that's simply embarrassing. The move is tantamount to an admission that the company can't get its stock price to triple digits the old fashioned way, through hard work, relentless creativity, and a stellar sales force. Instead, management performed the corporate version of breaking into the school's server to change a grade from a C- to an A+. Here's a question: name the last company that regained a leadership role in an industry after performing a reverse stock split? Good luck—we couldn't think of any. General Electric, once a "move fast and break things" company, now makes most of its profits from servicing the equipment it had previously sold to customers. Unlike an Apple, however, the firm isn't introducing the new products necessary to feed an ever-growing services business. When it finds itself in need of a new supply of cash, it simply sells one of its legacy businesses. Jeffrey Immelt, who spent too much time flying around on one of his two corporate jets (the other would travel behind in case of mechanical problems), started the great downturn at General Electric; unfortunately, Larry Culp doesn't seem to be the dynamic disruptor so desperately needed at the firm. Maybe he and Boeing's David Calhoun can have a few adult beverages one of these days and reminisce about the good old days at their respective firms.
General Electric was one of those global leaders which always had a place in our portfolios. No longer. GE is a case study in the importance of understanding what you own and why. We have a neighbor who had a gorgeous and enormous white pine in his back yard. One day we noticed that the needles at the top of the tree began turning brown. Instead of calling in a tree expert at the first sign of trouble, he figured the problem would take care of itself. Needless to say, the problem rapidly spread and the tree met its demise. A company used to be able to rest on its laurels and simply weather some boneheaded tactical or even strategic errors by upper management. Those days are gone, but the entrenched members of the board at a company like GE seem content to collect their pay and stay the course. Good luck. Pardon us if we choose not to board your next flight.
Market Week in Review
01. Yet another solid jobs report helps cobble together a positive week for the markets
It was difficult to find much wrong with the employment situation in America for the month of July, except for the fact that employers couldn't find enough workers to fill the open slots. Against expectations for 862,500 new nonfarm jobs for the month, companies actually hired 943,000 workers; June's 850,000 figure was also revised higher, to 938,000. The unemployment rate was, perhaps, the most pleasant surprise of all: it ticked down a whopping 50 basis points, from 5.9% to 5.4%. We are slowly but steadily getting back to the pre-pandemic unemployment rate of 3.5%, recorded in the halcyon days of February, 2020. The jobs report helped sway two market conditions: the 10-year Treasury rose from 1.228% to 1.303%, and all of the major indexes recorded gains for the week. Another five days of strong earnings releases also helped strengthen the stock market—especially the small caps. The Russell 2000 rose 1.46% on the week. On Monday, an interesting figure from the Bureau of Labor Statistics will be released: the Job Openings and Labor Turnover Survey, or JOLTS. Economists are predicting a near-record 9.1 million new job openings for the last business day of June. Quite a different story from a year ago.
Under the Radar Investment
Afry AB
Afry AB (AFXXF $17) is a $1.9 billion Swedish-Finnish engineering and consulting firm with projects in the energy, industrial, and infrastructure markets. On the infrastructure front, Afry provides sustainable technology solutions for railways, roads, and other transportation networks. In the energy sector, the firm constructs plants and provides market analysis for power generation, manufacturing facilities, and chemical refining plants. This is a play on a European recovery, as the overwhelming percentage of sales emanate from that continent. With a 15 P/E ratio and a 3.57% dividend yield, the company generated revenues of $2.07 billion in 2020 and $2.238 billion TTM, signaling a nice growth trajectory. Afry was founded in 1895 and trades on the Nasdaq Stockholm AB, formerly known as the Stockholm Stock Exchange.
Answer
Since February 16th, the Dow Jones Internet ETF hasn't been too impressive, with the aggregate shares down 0.47%. Those results appear stellar, however, when compared to a group of Chinese Internet stocks, which are down 53% in the same period. Alibaba, Tencent, and JD.com are the top three holdings in the group.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The communist party declares open season on domestic Internet companies...
Since February, when China began ramping up its attack on Net-based companies under its domain, the affected stocks have been plummeting. Since that time, what percentage have they, as a group, dropped in price?
Penn Trading Desk:
Penn: Purchased a play on the surging demand for outdoor recreational activities
Americans want to get out and explore their country to an extent not seen in a century. We added an undervalued name to the Intrepid Trading Platform which is well poised to take advantage of this trend, and one which happens to be on an aggressive acquisition spree to increase its breadth in the arena.
Penn: Placing a stop loss to protect our American Campus Communities gains
We purchased student housing REIT American Campus Communities right as analysts were predicting a dire situation for students returning to their respective colleges in the fall of 2020. We never bought into the "mass closings of dormitories" thesis and saw a great opportunity in the shares. In addition to strong growth potential, we were drawn to the company's 5.41% dividend yield. ACC has blown past our $40 initial price target and we are protecting our gains with a $47 stop loss on the shares.
Penn: Placing a stop loss to protect our MGM gains
We added the Las Vegas Strip's largest resort casino operator, MGM Resorts International, to the Penn Global Leaders Club last year as the industry was reeling from the pandemic. MGM shares surpassed our target price, are now up 130% from our purchase price, and have been falling back recently due to the Delta variant. We still believe in the company's long-term vision, but are not willing to fall below a triple-digit gain. We have placed a stop on the shares at $34, or $2 above our target price.
Penn: Placing a stop loss to protect our AVB gains
We opened our position in AvalonBay Communities (AVB $227) within the Strategic Income Portfolio in July of 2020, and this owner of 275 apartment communities—with 74,000 units—has seen its share price rise well above our initial price target of $182. Valuations seem a bit stretched, and with the share price hovering near an all-time high, we are putting protection on our position with a $218 stop loss.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Use diligence before clicking on that "unsubscribe" button at the bottom of spam emails
Remember when it was actually fun to find new emails waiting to be opened in your inbox? A few of us even remember AOL's iconic "you've got mail" notification. How times have changed. Americans are now inundated with mountains of new emails each and every day, and trying to cull the weeds from the garden can be challenging, to say the least. Instead of just whacking away by deleting them, knowing they are destined to return, many of us have tried to eradicate them using the mandatory (at least we thought it was) "Unsubscribe" button located in microscopic print somewhere near the bottom of each piece. We recently began to wonder, though, if the sage advice of not clicking on any link we're not extremely familiar with also held true for this innocuous little "opt out" key.
In fact, it turns out that malicious emails can, indeed, have unsubscribe links that lead to dangerous sites which can compromise or even infect your system with a virus. According to cybersecurity firm McAfee, following a few simple rules can help keep your system—and the treasure trove of data it probably holds—safe(r) from the dark web. If the email is from a legitimate company with which you are familiar, it should be safe to take a minute of your valuable time and go through the unsubscribe process. (Most are simple, others are purposefully irritating, making you put in the email address where they sent their junk!) If the email is from a company you don't recognize or one that seems a bit fishy, do not hit the unsubscribe link, just delete the email. For nefarious individuals and the algorithms they devise, this verifies that they have made a successful hit on a "validated" email address. If this is the case, the best scenario is more unwanted email heading your way. An uglier possibility is that the simple act of clicking on an unsubscribe button or link can lead to a virus being downloaded to your system. Another reason it pays to have good antivirus software protecting your system at all times.
Bottom line: simply delete or move to spam/junk any email that appears suspicious. In addition to having a strong web protection system installed on all of your devices, be sure and have it run scans on your system on a regular basis. Always keep your operating system up-to-date as well, as new malicious efforts are constantly being identified by software developers.
Beverages & Tobacco
09. Boston Beer's big bet on seltzer hits a wall, shares plummet
Boston Beer (SAM $716), maker of Sam Adams, has been our favorite name in booze/brewers for a number of years. Fiercely independent (as opposed to the big three, which are all now owned by foreign entities), the company simply makes an excellent product and has an exemplary management team, led by founder and Chairman of the Board Jim Koch. The sheen began to come off the name, however, when SAM started pushing a mediocre beer called Sam 76. That misstep was followed by another: the company bet big on hard seltzers—the modern version of Zima or Bartles & Jaymes wine coolers—at the expense (in our opinion) of their staple beer business. Hopefully they received the message investors sent them last week. After missing Q2 earnings badly ($4.75/sh vs the $6.60/sh expected), management admitted to increasing production of Truly hard seltzer to meet a summer demand which never fully manifested. For the quarter, SAM generated $602.8M in revenue versus expectations for $675.7M. To make matters worse, the firm cut its guidance for the remainder of the year. All of this was enough to pound SAM shares down 26% in one day and 31% from the week's peak to trough price.
We haven't owned SAM shares within the Penn portfolios since our disappointment over the capital expended on the ill-fated Sam 76 campaign, and the hard push into hard seltzers only reinforced our decision. Even if the company does pivot back to its staple, high-end beer business, the field is now crowded with new competitors. Analysts seem to be gravitating toward an average price target of $1,000, but we are waiting to see evidence that management fully understands the problem and is willing to make a mea culpa on their recent moves.
Automotive
08. Tesla earned over $1 billion this past quarter, ten times more than it made in the second quarter of 2020
EV maker Tesla (TSLA $658) just achieved its eighth-straight quarter with positive cash flow, earning $1.14 billion in profit between April and June. As if that wasn't impressive enough, the figure represents a ten-fold increase over the $104 million it earned in the same quarter last year. Revenue in Q2 doubled from last year, from $6.04 billion to $11.96 billion. It is difficult to find any flaws in the earnings report, but that didn't stop the chronic naysayers from pointing out why this level of growth is unsustainable. Those comments are rather ironic, considering the company had to weather recalls, a backlash from Chinese consumers, and a chip shortage over the course of the quarter. As for Musk, he hinted that this may be the last earnings conference call he would be taking part in, let alone leading. We can fully understand that decision.
Too many analysts continue to view Tesla as just another car company. Granted, were that the case, the multiples for the company are excessively high. We don't buy the premise, however. Tesla earned nearly $1 billion from its energy business last quarter, installing 60% more energy storage systems in homes than it did the previous quarter. Furthermore, we are most excited about the FSD (full self-driving) subscription service that should mushroom after future system upgrades make the company's vehicles fully autonomous. Then there is the company's advanced battery production facilities and its benchmark Supercharger DC fast-charting stations, which it will soon open to non-Tesla vehicles. We believe the Tesla growth story remains fully intact.
Global Exchanges & Indexes
07. The high risks associated with investing in Chinese tech companies
There have always been outsized risks associated with investing in Internet companies; when those companies happen to be based out of Communist China, those risks are compounded. For evidence, consider the popular KraneShares CSI China Internet ETF (KWEB $52). This fund holds fifty of the largest Chinese Internet companies listed on exchanges outside of Mainland China (presumably to mitigate risk). Alibaba and Tencent Holdings are the two largest positions within the fund. On 17 February, shares of KWEB hit $104.94; now, just five months later, they have been sliced precisely in half. Put another way, a $10,000 investment in the fund five months ago would now be worth $5,000.
China's general crackdown on publicly-traded companies and the more recent rules handed down to rein in for-profit education companies—such as the $4 billion New Oriental Education & Technology Group (EDU $2)—have been the major catalyst for the plummet. EDU has been a popular bet for investors looking to ring up profits in Chinese companies, with the shares jumping from $5 in 2019 to a peak of $20 this past February, before settling back down to their current $2 range. Why would China, which is bent on becoming the world's largest economy in short order, create a host of new rules designed to stifle the growth of their own companies? Note that KWEB focuses on shares of companies listed outside of the country; China wants to promote those listing on domestic exchanges—the largest being the Shanghai Stock Exchange. These rules are a shot across the bow to home-grown companies daring to list outside of the country. As has always been the case, investors are at the mercy of the all-powerful Chinese Communist Party.
There are so many wonderful opportunities right now across the globe, both in frontier/emerging and developed markets, that we urge investors to focus on areas which promote democratic values and offer citizens a high level of personal freedom. We don't believe it is worth the risk to have direct exposure to individual Chinese companies. The KWEB example shows how much risk is involved even in owning a basket of the largest publicly-traded companies based out of Mainland China.
Aerospace & Defense
06. Brain drain at Boeing: engineers and technicians are leaving the firm at an alarming rate
Bloomberg recently published an interesting and rather in-depth story on the flight of disillusioned engineers and technicians out of the exits at Boeing (BA $233). Certainly, the dual tragedies of recent 737 MAX crashes have impacted morale at the firm, but the problem has more to do with a management team wandering aimlessly in search of a strategic mission than it does with any specific events. When a former Boeing CEO announced, "no more 'moon shots,' it might as well have become the new company slogan. For young engineers, the excitement which once swirled around working for the world's largest aerospace and defense company has been replaced by, "well, at least it will look good on my résumé." Those workers have been taking their résumés to competing firms in droves as of late. And the recipients of this talent pool are not just the usual suspects such as SpaceX, Blue Origin, and Virgin Galactic.
Since the beginning of last year, over 3,200 engineers and technicians have bolted from the firm—a figure which accounts for nearly one-fifth of the 18,000 Boeing workers represented by the Society of Professional Engineering Employees in Aerospace (SPEEA) union. While many have been attracted to SpaceX's stunning recent successes and Elon Musk's bold vision for the future of humanity in space, Amazon has also been a major destination for these skilled workers. The idea of remaining in the Seattle area with a nice pay bump has been the major selling point for the latter. Amazon employs these specialists to increase the efficiency at their warehouses, much like they did with the Boeing factory floors.
The airliner catastrophes and a lack of a new generation passenger aircraft on the drawing boards at Boeing have not been the only forces driving workers away. On the space side of the equation, the company's recent Starliner failures stand in stark comparison to the stunning SpaceX successes. The company will have another chance to prove itself with the upcoming crew capsule test slated for this weekend, but even with a glaring success the firm has a long way to go. Meanwhile, European nemesis Airbus is increasingly outpacing Boeing with respect to both orders and deliveries. In the first quarter of 2021, Boeing delivered 77 aircraft versus 125 jets for Airbus—a 62% differential. By the end of Q1, Airbus reported a backlog of nearly 6,000 jets, while Boeing's backlog amounted to just shy of 5,000 aircraft. Furthermore, with no exciting new designs to show potential buyers, we are not sure what will be the catalyst for a comeback.
In our opinion, there is a horrendous vacuum leadership at Boeing, and the company's great turnaround cannot occur until a nearly clean sweep is made at the top. Unfortunately, the entire leadership team would disagree with that assessment. It will take major activist investor push to force the change required, but there hasn't been much action on that front either. At least we have SpaceX around to spearhead America's great return to manned spaceflight.
Media & Entertainment
05. Scarlett Johansson sues Disney over streaming release of Black Widow, Disney fires back with scathing retort
Our immediate thought was, "poor Scarlett, $20 million for one movie wasn't enough?" However, the more we delved into the story, the more it appears this will be one heck of a court battle. Actor Scarlett Johansson, number seven on the list of IMDb's hottest female actors of 2021, is suing Disney (DIS $ 176) for simultaneously releasing Black Widow, in which she plays the eponymous lead role, in theaters and on the Disney+ streaming service for a fee. Johansson's beef is this: the better the movie does at the box office, the more she will stand to make for her role. According to her attorney, the streaming release was done primarily for Disney to add subscribers, and a large number of viewers decided to forego the theater and stream instead. The figures show that Disney did, indeed, fatten its wallet by charging $30 for Disney+ members to stream the movie. Over the course of its opening weekend, Black Widow raked in $80 million at the US box office, $78 million at the worldwide box office, and a whopping $60 million from its Disney+ platform.
Disney shot back directly at Johansson, saying that "the lawsuit is especially sad and distressing in its callous disregard for the horrific and prolonged global effects of the COVID-19 pandemic." Yes, Disney, we are sure you released the movie on your streaming service as a public service, which is why you charged paying subscribers an additional $30 a pop. Actually, the more we mull the situation over, the more we tend to side with Johansson. Based on other movies released during the pandemic and the way in which other studios compensated their talent, she probably would have made around $25 million more for the movie than she did. In addition to a probable loss in the courts, Disney will suffer a real black eye in Hollywood over this one.
When Bob Chapek took over at Disney, we cashed out—despite having owned the company in the Penn Global Leaders Club for years. It appears we made the right call. Nothing matters like management.
Capital Markets
04. HOOD's wild ride: platform for the meme stocks turns into one itself
By most accounts, it was a lackluster debut. The much-anticipated IPO of financial services platform Robinhood (HOOD $55) finally occurred last week, but shares ended up tumbling 12% from their $38 initial offering price almost immediately. Considering the platform boasts some 20 million accounts, one would have expected fireworks out of the gate, akin to an Airbnb ($145) or a DoorDash (DASH $176). But, alas, the WallStreetBets/reddit monster ended up harming the very company which fomented the movement, with some on the social media sites even calling on members to short the stock on day one. That is rich, considering users' raison d'être seemed to be destroying the shorts. ARK Investment's Cathie Wood, someone whom we respect a lot, may have played a part in the turnaround which occurred after day one by buying 1.85 million shares below the IPO price. Despite Wood's buy, we tend to agree with Morningstar's fair value of $30 on the shares, meaning they have some additional falling to do before we are interested.
When the reckoning does hit the markets, and it will, expect HOOD to get pounded. The world where an AMC, which is worth $5 per share, trades at $38 per share will eventually come crumbling down, and some semblance of sanity will return. At that point, there will be a lot of formerly-overvalued stocks worth picking up, and plenty we still wouldn't touch. As for HOOD, if the $30 fair value is accurate that means $25 per share might be a good point to jump in.
Automotive
03. We called it: Nikola's founder, Trevor Milton indicted on fraud charges
We have been calling EV maker Nikola (NKLA $11) little short of a sham for a couple of years now. Our opinion was cemented after we saw the company's founder, Trevor Milton, in several interviews. Based on decades of CEO-watching, we got a really bad feeling about the founder and his alleged product lineup. While the company was spared in the indictment, the US government has just charged the founder with three counts of fraud, stating that he lied to investors "about nearly all aspects of the business." We may have had a bad feeling about the firm, but investors certainly didn't: NKLA shares went from $10 in March of 2020 to $80 three months later, since dropping back to the $12 range. While at their high, Milton had a paper net worth of roughly $9 billion; that figure is now floating around $1 billion, but we imagine there is plenty more pain ahead. The wheels became to come off the cart last September after Hindenburg Research published a scathing article on the EV firm, pretty much echoing the government case—or vice versa. Shortly after the report was released, Milton was out at the firm he started and a deal the company cobbled together with General Motors fell apart (we excoriated GM when it made the deal). If we want to ignore the company's financials (basically zero revenue) and focus on production, try this on for size: the company has produced zero vehicles for public sale.
Tesla was enormously successful, so we should just jump into an EV maker that sounds like the next Tesla, right? Heck, this company even took the famous inventor's first name! Madness. It is understandable that the financials wouldn't look stellar on a nascent company trying to break into an industry with a pretty tall barrier to entry, but we are talking about a company that went public without having one vehicle roll off of an assembly line. NKLA may not have been a meme stock, but the same level of (ir)rational thought went into the purchase of the shares.
Industrial Conglomerates
02. A sure sign of desperation: financial engineering has replaced cutting-edge engineering at General Electric
I feel bad for General Electric (GE $105); embarrassed for this once-great American powerhouse. Has Edison's firm really been reduced to this? Some companies have a "move fast and break things" mentality. GE's grand strategic vision is "let's do a reverse stock split at just the right level to move our share price into triple digits like our competition." I mean, that's simply embarrassing. The move is tantamount to an admission that the company can't get its stock price to triple digits the old fashioned way, through hard work, relentless creativity, and a stellar sales force. Instead, management performed the corporate version of breaking into the school's server to change a grade from a C- to an A+. Here's a question: name the last company that regained a leadership role in an industry after performing a reverse stock split? Good luck—we couldn't think of any. General Electric, once a "move fast and break things" company, now makes most of its profits from servicing the equipment it had previously sold to customers. Unlike an Apple, however, the firm isn't introducing the new products necessary to feed an ever-growing services business. When it finds itself in need of a new supply of cash, it simply sells one of its legacy businesses. Jeffrey Immelt, who spent too much time flying around on one of his two corporate jets (the other would travel behind in case of mechanical problems), started the great downturn at General Electric; unfortunately, Larry Culp doesn't seem to be the dynamic disruptor so desperately needed at the firm. Maybe he and Boeing's David Calhoun can have a few adult beverages one of these days and reminisce about the good old days at their respective firms.
General Electric was one of those global leaders which always had a place in our portfolios. No longer. GE is a case study in the importance of understanding what you own and why. We have a neighbor who had a gorgeous and enormous white pine in his back yard. One day we noticed that the needles at the top of the tree began turning brown. Instead of calling in a tree expert at the first sign of trouble, he figured the problem would take care of itself. Needless to say, the problem rapidly spread and the tree met its demise. A company used to be able to rest on its laurels and simply weather some boneheaded tactical or even strategic errors by upper management. Those days are gone, but the entrenched members of the board at a company like GE seem content to collect their pay and stay the course. Good luck. Pardon us if we choose not to board your next flight.
Market Week in Review
01. Yet another solid jobs report helps cobble together a positive week for the markets
It was difficult to find much wrong with the employment situation in America for the month of July, except for the fact that employers couldn't find enough workers to fill the open slots. Against expectations for 862,500 new nonfarm jobs for the month, companies actually hired 943,000 workers; June's 850,000 figure was also revised higher, to 938,000. The unemployment rate was, perhaps, the most pleasant surprise of all: it ticked down a whopping 50 basis points, from 5.9% to 5.4%. We are slowly but steadily getting back to the pre-pandemic unemployment rate of 3.5%, recorded in the halcyon days of February, 2020. The jobs report helped sway two market conditions: the 10-year Treasury rose from 1.228% to 1.303%, and all of the major indexes recorded gains for the week. Another five days of strong earnings releases also helped strengthen the stock market—especially the small caps. The Russell 2000 rose 1.46% on the week. On Monday, an interesting figure from the Bureau of Labor Statistics will be released: the Job Openings and Labor Turnover Survey, or JOLTS. Economists are predicting a near-record 9.1 million new job openings for the last business day of June. Quite a different story from a year ago.
Under the Radar Investment
Afry AB
Afry AB (AFXXF $17) is a $1.9 billion Swedish-Finnish engineering and consulting firm with projects in the energy, industrial, and infrastructure markets. On the infrastructure front, Afry provides sustainable technology solutions for railways, roads, and other transportation networks. In the energy sector, the firm constructs plants and provides market analysis for power generation, manufacturing facilities, and chemical refining plants. This is a play on a European recovery, as the overwhelming percentage of sales emanate from that continent. With a 15 P/E ratio and a 3.57% dividend yield, the company generated revenues of $2.07 billion in 2020 and $2.238 billion TTM, signaling a nice growth trajectory. Afry was founded in 1895 and trades on the Nasdaq Stockholm AB, formerly known as the Stockholm Stock Exchange.
Answer
Since February 16th, the Dow Jones Internet ETF hasn't been too impressive, with the aggregate shares down 0.47%. Those results appear stellar, however, when compared to a group of Chinese Internet stocks, which are down 53% in the same period. Alibaba, Tencent, and JD.com are the top three holdings in the group.
Headlines for the Week of 27 Jun—03 Jul 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The movement was set in motion well before the Declaration of Independence...
While the final wording of the American Declaration of Independence was approved by the Second Continental Congress on 04 July 1776, the die had already been cast. What battle served as the demarcation point, the event from which there was no turning back?
Penn Trading Desk:
Cowen: Under Armour is "best idea"
Shares of sports apparel manufacturer Under Armour (UA $19, UAA $21) shot up around 4% following an upgrade by investment research firm Cowen, which put it on its "best idea" list. Analysts at the firm believe that UA is well poised to take advantage of the return of team sports and a back to school season which will be largely free from mask requirements. Cowen has an overweight rating on the company with a price target of $31 per share. We are not as bullish, as Under Armour is heavily dependent on sales in the Asia Pacific region, and tensions remain high (rightfully so) between China and the US. We also don't like the multi-share-class gimmick. An investor can buy Class A shares under the ticker UA and have one vote per share. The same investor could buy Class C shares under the ticker UAA and have no voting rights. Of course, the anointed company insiders like Kevin Plank own Class B shares, which the hoi polloi cannot touch—and which carry around ten votes per share. Gimmickry. For the record, six years ago UAA was trading above $51 per share.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Business & Professional Services
10. DoorDash is ramping up its grocery delivery business with Albertsons partnership
With over 450,000 merchants, 20 million consumer/customers, and one million dashers on its platform, DoorDash (DASH $175) is already the largest food delivery service in the United States—despite just going public late last year. How far the company has come in seven years, from back when it was known as Palo Alto Delivery, Inc. Now, the San Fran-based firm is entering the competitive grocery delivery business, inking a deal with grocer Albertsons (ACI $20) to offer delivery of the chain's goods on its marketplace app. DashPass customers will be able to order grocery and household items from nearly 2,000 Albertsons-owned stores, which include Safeway, Jewel-Osco, and Vons. For a monthly subscription fee of $9.99, members receive free deliveries and reduced fees from thousands of restaurants, grocery stores, and convenience stores, according to the DoorDash website. Over 40,000 grocery items will be available on the marketplace app. DoorDash has also recently entered into delivery agreements with PetSmart and Bed Bath & Beyond, in addition to making a major international move into Japan. In 2020, DASH generated revenues of $2.9 billion, an increase of 229% over 2019 revenues (which, themselves, were up 310% from the prior year).
There are going to be a handful of big, long-term winners in this new niche industry. In addition to the obvious mega-cap players (Amazon, Walmart), we see DoorDash and Uber increasing their market share for years to come. Actually, it would be relatively safe to bet on any of these four names going forward, assuming the fit is right for the respective portfolio.
Cryptocurrencies
09. The real reason China is cracking down on cryptos
Oh, the naive press. If only they would give esteemed American establishments the same deference they show to the Chinese Communist Party. The big price drop in cryptos at the start of the week came on the heels of a major Chinese crackdown; the press got that part of the story right, but what they missed was the real catalyst behind the move. Absurdly, one major business publication said, "Concerns about the environmental impact (of the computers that mine Bitcoin) continue to swirl." Yep, they nailed it. The greatest polluter in the world is suddenly concerned that Bitcoin mining might make the air over Xinjiang a little bit browner.
The real reason the CCP ordered the People's Bank of China to warn lenders to cease using cryptocurrencies, and for the major provinces where mining takes place to crack down on production, is two-fold. First, by their very nature, digital coins are hard to control, and the CCP is all about control. Once the coins have been mined they can travel freely through the ether, generally untouchable by a central power. The second reason has to do with China's own ambitions in the arena. As we have mentioned before, the country wants to create a digital yuan that will ultimately (in the eyes of the party) become the world's leading currency, supplanting the dollar. The incredible amount of hydropower used for mining should be reserved for the state's own coinage, not the free market's. Don't believe anything you hear about the government's sudden concern over the environment, or the need to preserve electricity for the Chinese people—only journalists are gullible enough to fall for that straw man.
When Bitcoin rose above $64,000, the experts were pointing to $100,000 as the next major stop. On Tuesday, the coins broke below $29,000 and there isn't much clarity on where prices are headed from here. The China-induced drop is interesting; if Chinese mining goes offline, shouldn't that bode well for the price of the commodity? For those with FOMO, we recommend opening a Coinbase account and buying a few of the fifty or so cryptos available on the platform.
Consumer Finance
08. And the world's dumbest new idea goes to...drumroll, please...the credit card designed to pay your rent*
I love history. Reading about the brilliant successes and colorful failures of the past and considering how their lessons can be applied to current, real-world situations. This can be an effective tool in separating the right course of action from the wrong, or the smart from incredibly stupid. In the latter camp, fintech startup Kairos just launched a new loyalty program, Bilt Rewards, tied to its co-branded Bilt Mastercard which is being affectionately labeled "the renter's credit card." Kairos founder and CEO Ankur Jain said it's not fair that credit card users gain rewards for traveling or shopping (paraphrasing), but that renters haven't been able to earn rewards on their largest expenditure, their rent payment. That is some stunningly convoluted thinking.
The concept is straightforward: pay your rent using your Bilt Mastercard and start earning 250 rewards points per rent payment, along with any other perks your landlord wants to throw in. And don't worry about checking whether or not your apartment is a qualifying property; if it is, you should automatically receive an email within the next six months informing you of your eligibility. And the more you use your card, the higher you can climb in the membership levels of Blue, Silver, Gold, and Platinum status. Bilt Rewards can be redeemed for such things as travel, fitness classes, even art purchases through the Bilt Collection. When pressed on the credit card's interest rate, Jain said that it should be in the "14-22% range...it's standard."
Remember when it was a sign of prestige to carry an American Express card that had to be paid off each month? This card is not that. The idea of putting rent on a credit card is one of the most irresponsible concepts to manifest as of late, and that is saying a lot. Rewarding people for doing the wrong thing, encouraging them to put their rent on a credit card when odds are strong they don't even have an IRA set up, is sickening. Shame on the founder of this company, and on Mastercard for going along with the deal. And the same goes for the Bilt Rewards Alliance of property owners participating in this scheme.
Global Strategy: East & Southeast Asia
07. Communist China forces shutdown of Hong Kong's last remaining pro-democracy newspaper
We recall, back in the late 1990s, how silly the argument seemed: although sovereignty over the British colony of Hong Kong was being passed to China, many so-called experts were telling us that the communist nation wouldn't dare kill their golden goose. Granted, it took a few decades to quell the basic hallmarks of a free society, but this week pretty much sealed the deal. Apple Daily, the wealthy island's last remaining pro-democracy newspaper, has been killed. It began with the (second) jailing of the paper's majority owner, Jimmy Lai. Then, Hong Kong's puppet regime froze the company's assets and seized its journalists' computers. The final straw was the arrest of two top executives under a new national security law Beijing imposed on the island to stifle dissent. Following that move, Apple Daily reported that both its print edition and website would cease operations. It is the beginning of a full-scale collapse of freedom in Hong Kong, which begs the question: how much longer can Taiwan remain a free country? Furthermore, what will the United States, which is bound by agreement to protect the nation from Chinese attack, do when the inevitable begins to unfold.
America wouldn't have dreamed of accepting wave after wave of goods-laden shipping containers from the Soviet Union during the Cold War, yet we are funding the insatiable appetite of Communist China, and its dreams of global domination, by welcoming in some $500 billion per year of goods from that country, even though China only imports around $130 billion per year of US goods. This situation must change. If US companies are unwilling to break the deadly cycle and search elsewhere around the world for imports, they must be strongly coerced by the federal government to do so. Better yet, they should consider saving on the shipping costs by manufacturing domestically—or at least within the USMCA region.
Pharmaceuticals
06. More exciting news on the Alzheimer's front
For such a horrible and deadly disease which hasn't seen much progress on the therapies front over the past two decades, researchers may finally be rounding the corner with respect to Alzheimer's. Last week was the exciting news that Biogen's (BIIB $351) aducanumab (trade name Aduhelm) had been given the green light by the FDA; now, the organization has granted breakthrough therapy designation to Eli Lilly's (LLY $234) Alzheimer's therapy donanemab. This designation will speed along the drug's approval process, the application for which Lilly plans to submit later this year. Despite the naysayers' multi-faceted complaints about these drugs, the FDA is doing the right thing by allowing them to go forward. These positive rulings will help speed along the development of other drugs to treat the disease, and ultimately the exorbitant prices for the therapies will fall. The FDA has smoothed the way for pharma and biotech companies to pump increased R&D spending into the category, giving hope to the families of the six million Americans suffering with this horrendous condition.
We continue to overweight the Health Care sector and a number of industries within the space. On the back of stunning advances in medical technology, we can expect to see a biotech and pharma boom over the next decade, with new therapies for diseases which have stymied researchers for decades. The greatest threat to this boom would be increased government regulatory control over the industry, but we see that as an unlikely scenario. We hold a number of health care companies and ETFs in the Dynamic Growth Strategy, Penn Global Leaders Club, and Penn New Frontier Fund.
Space Tourism
05. Virgin Galactic gets OK from FAA to fly passengers into space
Virgin Galactic (SPCE $54) shares were soaring 34% higher on Friday following news that the FAA granted approval for the company to begin sending people into space aboard its spaceplanes. The full commercial space-launch license opens the door for space tourism, the firm's only immediate source of revenues. It is interesting to note that Blue Origin, which is owned by Jeff Bezos, has yet to receive this FAA stamp of approval, despite Bezos recently announcing that he would be a part of the company's first manned flight scheduled for July. When pressed about the Blue Origin certification, an FAA spokesperson said that the agency would "make a decision when and if all regulatory requirements are met." As for Virgin, the company said it has already sold over 600 tickets for rides aboard its SpaceShipTwo spaceplanes, with each one going for around $250,000. The company plans to have a fleet of five craft launching from its Spaceport America launch site in New Mexico. Ultimately, the plans call for launches taking place from multiple sites around the country, with destinations ranging from major cities around the world, to space-based hotels in orbit. Regarding the FAA certification, it is interesting to note that the agency has no authority over spacecraft operating above the atmosphere, but they do control the safety of the airways traversed by the spacecraft between launch and orbit.
At $54 per share, SPCE seems to have a pretty lofty valuation—even though we are excited about the company's strategic plans. It is normal for a nascent growth company to have no P/E ratio, as they often have no earnings. What is unique about Virgin Galactic is its $13 billion market cap on a foundation of virtually zero revenues as well—other than the 250-large they collected for each ticket sold for the promise of a future flight.
Textiles, Apparel, & Luxury Goods
04. PVH is selling its legacy clothing lines to Authentic Brands
Apparel manufacturing firm PVH (PVH $109) is selling four of its legacy brands, or what they call their Heritage Brands, to Authentic for $220 million. Why would the company want to part ways with prominent names Izod, Van Heusen, Arrow, and Geoffrey Beene? Management says it is doing so to "drive the next chapter of sustainable, profitable, growth," which will be built on a foundation of the Calvin Kline and Tommy Hilfiger brands. The company also said it plans on "supercharging" its e-commerce channel. That actually makes sense in this new world of hybrid workers buying fewer suits and more work-casual clothing. It is also interesting to note that this is the first major move by new CEO (Feb, 2021) Stefan Larsson—though longtime CEO and well-respected industry insider Manny Chirico did take on the role of Chairman of the Board. Not counting Chirico, the average tenure of PVH's management team is just 1.5 years. As for the buyer of these brands, privately-held Authentic is collecting quite the portfolio. In addition to these four names, the company owns Forever 21, Lucky Brand, Nine West, and part of Brooks Brothers—which it helped buy out of bankruptcy last year. Before the pandemic, PVH had an annual revenue of approximately $10 billion and a net income which was perennially in the black. Last year, the firm notched $7 billion in sales and lost $1.16 billion.
We actually like the move by $7.7 billion PVH to sell off these legacy brands, but is the stock a buy? We don't think so. It is estimated that the company will generate $6.73 in earnings per share in FY2022, which is about what it generated in FY2017. The share price ranged from $84 to $139 that year, and we wouldn't touch it above $75 per share. Perhaps the fledgling management team will impress, but this single move is really all we have to go on thus far.
Interactive Media & Services
03. Facebook joins the Trillion Dollar Club after judge throws out the FTC's complaint
Talk about some rarified air: Facebook (FB $356) joined an elite group of companies carrying a market cap of over one trillion dollars after a US District Court judge threw out the antitrust complaints against the company filed by the Federal Trade Commission and virtually all states' attorneys general. That dismissal led to a 4.25% pop in the company's share price, giving it a $1.009 trillion valuation. Facebook joins Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL) in the tiny group of companies which can boast of a $1 trillion size. While Judge James Boasberg disputed the FTC's claim that Facebook was a monopoly, he did leave the door open for the agency to amend its complaint and submit a revised filing. Had it been successful, the complaint could have forced Facebook to divest itself of both the WhatsApp and Instagram platforms. The court seemed to excoriate the plaintiffs' lack of effort, at one point in the ruling saying that the allegations "do not even provide an estimated figure or range for Facebook's market share at any point over the past ten years...." Ouch. It seems as though the judge felt there was some hubris involved in the suit, with an "expectation" that the court would find fault in Facebook's business practices. Arrogance and hubris among government officials? Shocking.
Despite all the bluster among elected officials about cutting these big social media companies down to size, we think very little gets accomplished (to that end) in the near future. As a matter of fact, a 20% investment in each of these five behemoths—beginning today—would probably yield some impressive results if we were to go forward five years in time and gauge the investment bucket's return.
Restaurants
02. Krispy Kreme: Love the doughnuts, hate the stock
More technically, love the doughnuts, hate the financial engineering firm that is bringing the company public...again. Krispy Kreme, former symbol KKD, used to be one of our favorite trading stocks. We actually had a client at A.G. Edwards who would only trade two stocks, KKD and WMT, based on whether the economy was in an expansionary period or a contraction phase. Fast forward to 2016, when KKD was taken private by the powerful German Reimann family, via their JAB Holding Company. JAB had also gobbled up the likes of Peet's Coffee, Panera Bread, Keurig Dr. Pepper, Einstein Bros. Bagels, and a host of other fast food and consumer goods companies. As with all financial engineering firms, the strategy is to make as much money as possible with as little effort as possible, and one popular tactic is the repackaging of companies to bring public once again under a shiny new symbol. That is precisely what JAB did with Krispy Kreme, which now trades under the new—admittedly catchier—symbol DNUT ($19). Perhaps the most insulting aspect of this game of smoke and mirrors is the fact that JAB will retain 78% control of the firm, so suckers...er, investors...beware. Investors did appear to be leery of the game: after planning to offer $26.7 million shares in the range of $21 to $24, soft demand led to the holding company selling 29.4 million shares at $17. While they did rocket up 24% from the offering price on IPO day, the shares steadily declined from there. DNUT shares closed out their first week at $19.12.
We have to wonder how many DNUT investors were aware of the company's back story as opposed to just thinking, "cool, Krispy Kreme is going public and the shares are cheap." They are actually not cheap. In fact, Amazon shares at $3,510 are "cheaper" than DNUT at $19. But none of that seems to matter in these days of meme stocks and SPACs. If shares are $25 or less, it must be a good deal, so let's buy in and watch the confetti fall on our iPhone screen.
Market Week in Review
01. Strong June jobs report leads to weekly gains across the board
All of the major indexes—along with the price of crude—rose over 1% this week on the back of a solid June jobs report. The economy added 850,000 new jobs for the month, and while the unemployment rate ticked up 10 basis points (to 5.9%), that was simply due to more Americans re-entering the job market. Investors actually liked the small uptick, as it lessens the odds of the Fed tightening sooner than expected. In a sign that employers are having a difficult time filling open spots, hourly wages in the private sector rose a robust 3.6% from a year ago. Among the sectors and market caps, big tech names led the week's rally, with the NASDAQ jumping 1.94%. Crude oil rose 1.62% on the week, trading a whopping 55% higher on the year. The first two months of the "worst six months of the year" have come and gone, and we are impressed at how well the markets have held up thus far.
Under the Radar Investment
Kratos Defense & Security Solutions
Kratos Defense & Security Solutions Inc (KTOS $28), despite its small size ($3.7B), is a key player in America's defense and aerospace infrastructure. The company develops and fields advanced systems and platforms for national security and communications needs. Its Skyborg program is focused on expanding the envelope of unmanned aircraft use, especially as related to artificial intelligence; while its Defense and Rocket Support Services (DRSS) division develops hypersonic test vehicles for America's missile defense initiative. Civilian and government satellite operators, meanwhile, rely on Kratos as their strategic supplier of end-to-end enterprise products. We especially like the company's size and financial health, and believe the company will continue along its strong growth trajectory.
Answer
While the battles of Lexington and Concord, which were fought on 19 April 1775, technically kicked off the American Revolution, it was the Battle of Bunker Hill, which was actually fought on Breed's Hill on 17 June 1775, that made both sides in the fight realize there was no turning back. While the British won the battle, it was a Pyrrhic victory: the number of British killed or wounded (1,054, including 89 officers) was over twice that suffered on the American side. The King's troops and their loyalist allies in Boston were left stunned and shocked, while the "loss" served as a rallying cry for the patriots' cause. George Washington, who had been appointed commander of the Continental Army just three days prior, arrived shortly after the conclusion of the battle. Soon, the disparate militias of the various colonies would be forged into one American force.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The movement was set in motion well before the Declaration of Independence...
While the final wording of the American Declaration of Independence was approved by the Second Continental Congress on 04 July 1776, the die had already been cast. What battle served as the demarcation point, the event from which there was no turning back?
Penn Trading Desk:
Cowen: Under Armour is "best idea"
Shares of sports apparel manufacturer Under Armour (UA $19, UAA $21) shot up around 4% following an upgrade by investment research firm Cowen, which put it on its "best idea" list. Analysts at the firm believe that UA is well poised to take advantage of the return of team sports and a back to school season which will be largely free from mask requirements. Cowen has an overweight rating on the company with a price target of $31 per share. We are not as bullish, as Under Armour is heavily dependent on sales in the Asia Pacific region, and tensions remain high (rightfully so) between China and the US. We also don't like the multi-share-class gimmick. An investor can buy Class A shares under the ticker UA and have one vote per share. The same investor could buy Class C shares under the ticker UAA and have no voting rights. Of course, the anointed company insiders like Kevin Plank own Class B shares, which the hoi polloi cannot touch—and which carry around ten votes per share. Gimmickry. For the record, six years ago UAA was trading above $51 per share.
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Business & Professional Services
10. DoorDash is ramping up its grocery delivery business with Albertsons partnership
With over 450,000 merchants, 20 million consumer/customers, and one million dashers on its platform, DoorDash (DASH $175) is already the largest food delivery service in the United States—despite just going public late last year. How far the company has come in seven years, from back when it was known as Palo Alto Delivery, Inc. Now, the San Fran-based firm is entering the competitive grocery delivery business, inking a deal with grocer Albertsons (ACI $20) to offer delivery of the chain's goods on its marketplace app. DashPass customers will be able to order grocery and household items from nearly 2,000 Albertsons-owned stores, which include Safeway, Jewel-Osco, and Vons. For a monthly subscription fee of $9.99, members receive free deliveries and reduced fees from thousands of restaurants, grocery stores, and convenience stores, according to the DoorDash website. Over 40,000 grocery items will be available on the marketplace app. DoorDash has also recently entered into delivery agreements with PetSmart and Bed Bath & Beyond, in addition to making a major international move into Japan. In 2020, DASH generated revenues of $2.9 billion, an increase of 229% over 2019 revenues (which, themselves, were up 310% from the prior year).
There are going to be a handful of big, long-term winners in this new niche industry. In addition to the obvious mega-cap players (Amazon, Walmart), we see DoorDash and Uber increasing their market share for years to come. Actually, it would be relatively safe to bet on any of these four names going forward, assuming the fit is right for the respective portfolio.
Cryptocurrencies
09. The real reason China is cracking down on cryptos
Oh, the naive press. If only they would give esteemed American establishments the same deference they show to the Chinese Communist Party. The big price drop in cryptos at the start of the week came on the heels of a major Chinese crackdown; the press got that part of the story right, but what they missed was the real catalyst behind the move. Absurdly, one major business publication said, "Concerns about the environmental impact (of the computers that mine Bitcoin) continue to swirl." Yep, they nailed it. The greatest polluter in the world is suddenly concerned that Bitcoin mining might make the air over Xinjiang a little bit browner.
The real reason the CCP ordered the People's Bank of China to warn lenders to cease using cryptocurrencies, and for the major provinces where mining takes place to crack down on production, is two-fold. First, by their very nature, digital coins are hard to control, and the CCP is all about control. Once the coins have been mined they can travel freely through the ether, generally untouchable by a central power. The second reason has to do with China's own ambitions in the arena. As we have mentioned before, the country wants to create a digital yuan that will ultimately (in the eyes of the party) become the world's leading currency, supplanting the dollar. The incredible amount of hydropower used for mining should be reserved for the state's own coinage, not the free market's. Don't believe anything you hear about the government's sudden concern over the environment, or the need to preserve electricity for the Chinese people—only journalists are gullible enough to fall for that straw man.
When Bitcoin rose above $64,000, the experts were pointing to $100,000 as the next major stop. On Tuesday, the coins broke below $29,000 and there isn't much clarity on where prices are headed from here. The China-induced drop is interesting; if Chinese mining goes offline, shouldn't that bode well for the price of the commodity? For those with FOMO, we recommend opening a Coinbase account and buying a few of the fifty or so cryptos available on the platform.
Consumer Finance
08. And the world's dumbest new idea goes to...drumroll, please...the credit card designed to pay your rent*
I love history. Reading about the brilliant successes and colorful failures of the past and considering how their lessons can be applied to current, real-world situations. This can be an effective tool in separating the right course of action from the wrong, or the smart from incredibly stupid. In the latter camp, fintech startup Kairos just launched a new loyalty program, Bilt Rewards, tied to its co-branded Bilt Mastercard which is being affectionately labeled "the renter's credit card." Kairos founder and CEO Ankur Jain said it's not fair that credit card users gain rewards for traveling or shopping (paraphrasing), but that renters haven't been able to earn rewards on their largest expenditure, their rent payment. That is some stunningly convoluted thinking.
The concept is straightforward: pay your rent using your Bilt Mastercard and start earning 250 rewards points per rent payment, along with any other perks your landlord wants to throw in. And don't worry about checking whether or not your apartment is a qualifying property; if it is, you should automatically receive an email within the next six months informing you of your eligibility. And the more you use your card, the higher you can climb in the membership levels of Blue, Silver, Gold, and Platinum status. Bilt Rewards can be redeemed for such things as travel, fitness classes, even art purchases through the Bilt Collection. When pressed on the credit card's interest rate, Jain said that it should be in the "14-22% range...it's standard."
Remember when it was a sign of prestige to carry an American Express card that had to be paid off each month? This card is not that. The idea of putting rent on a credit card is one of the most irresponsible concepts to manifest as of late, and that is saying a lot. Rewarding people for doing the wrong thing, encouraging them to put their rent on a credit card when odds are strong they don't even have an IRA set up, is sickening. Shame on the founder of this company, and on Mastercard for going along with the deal. And the same goes for the Bilt Rewards Alliance of property owners participating in this scheme.
Global Strategy: East & Southeast Asia
07. Communist China forces shutdown of Hong Kong's last remaining pro-democracy newspaper
We recall, back in the late 1990s, how silly the argument seemed: although sovereignty over the British colony of Hong Kong was being passed to China, many so-called experts were telling us that the communist nation wouldn't dare kill their golden goose. Granted, it took a few decades to quell the basic hallmarks of a free society, but this week pretty much sealed the deal. Apple Daily, the wealthy island's last remaining pro-democracy newspaper, has been killed. It began with the (second) jailing of the paper's majority owner, Jimmy Lai. Then, Hong Kong's puppet regime froze the company's assets and seized its journalists' computers. The final straw was the arrest of two top executives under a new national security law Beijing imposed on the island to stifle dissent. Following that move, Apple Daily reported that both its print edition and website would cease operations. It is the beginning of a full-scale collapse of freedom in Hong Kong, which begs the question: how much longer can Taiwan remain a free country? Furthermore, what will the United States, which is bound by agreement to protect the nation from Chinese attack, do when the inevitable begins to unfold.
America wouldn't have dreamed of accepting wave after wave of goods-laden shipping containers from the Soviet Union during the Cold War, yet we are funding the insatiable appetite of Communist China, and its dreams of global domination, by welcoming in some $500 billion per year of goods from that country, even though China only imports around $130 billion per year of US goods. This situation must change. If US companies are unwilling to break the deadly cycle and search elsewhere around the world for imports, they must be strongly coerced by the federal government to do so. Better yet, they should consider saving on the shipping costs by manufacturing domestically—or at least within the USMCA region.
Pharmaceuticals
06. More exciting news on the Alzheimer's front
For such a horrible and deadly disease which hasn't seen much progress on the therapies front over the past two decades, researchers may finally be rounding the corner with respect to Alzheimer's. Last week was the exciting news that Biogen's (BIIB $351) aducanumab (trade name Aduhelm) had been given the green light by the FDA; now, the organization has granted breakthrough therapy designation to Eli Lilly's (LLY $234) Alzheimer's therapy donanemab. This designation will speed along the drug's approval process, the application for which Lilly plans to submit later this year. Despite the naysayers' multi-faceted complaints about these drugs, the FDA is doing the right thing by allowing them to go forward. These positive rulings will help speed along the development of other drugs to treat the disease, and ultimately the exorbitant prices for the therapies will fall. The FDA has smoothed the way for pharma and biotech companies to pump increased R&D spending into the category, giving hope to the families of the six million Americans suffering with this horrendous condition.
We continue to overweight the Health Care sector and a number of industries within the space. On the back of stunning advances in medical technology, we can expect to see a biotech and pharma boom over the next decade, with new therapies for diseases which have stymied researchers for decades. The greatest threat to this boom would be increased government regulatory control over the industry, but we see that as an unlikely scenario. We hold a number of health care companies and ETFs in the Dynamic Growth Strategy, Penn Global Leaders Club, and Penn New Frontier Fund.
Space Tourism
05. Virgin Galactic gets OK from FAA to fly passengers into space
Virgin Galactic (SPCE $54) shares were soaring 34% higher on Friday following news that the FAA granted approval for the company to begin sending people into space aboard its spaceplanes. The full commercial space-launch license opens the door for space tourism, the firm's only immediate source of revenues. It is interesting to note that Blue Origin, which is owned by Jeff Bezos, has yet to receive this FAA stamp of approval, despite Bezos recently announcing that he would be a part of the company's first manned flight scheduled for July. When pressed about the Blue Origin certification, an FAA spokesperson said that the agency would "make a decision when and if all regulatory requirements are met." As for Virgin, the company said it has already sold over 600 tickets for rides aboard its SpaceShipTwo spaceplanes, with each one going for around $250,000. The company plans to have a fleet of five craft launching from its Spaceport America launch site in New Mexico. Ultimately, the plans call for launches taking place from multiple sites around the country, with destinations ranging from major cities around the world, to space-based hotels in orbit. Regarding the FAA certification, it is interesting to note that the agency has no authority over spacecraft operating above the atmosphere, but they do control the safety of the airways traversed by the spacecraft between launch and orbit.
At $54 per share, SPCE seems to have a pretty lofty valuation—even though we are excited about the company's strategic plans. It is normal for a nascent growth company to have no P/E ratio, as they often have no earnings. What is unique about Virgin Galactic is its $13 billion market cap on a foundation of virtually zero revenues as well—other than the 250-large they collected for each ticket sold for the promise of a future flight.
Textiles, Apparel, & Luxury Goods
04. PVH is selling its legacy clothing lines to Authentic Brands
Apparel manufacturing firm PVH (PVH $109) is selling four of its legacy brands, or what they call their Heritage Brands, to Authentic for $220 million. Why would the company want to part ways with prominent names Izod, Van Heusen, Arrow, and Geoffrey Beene? Management says it is doing so to "drive the next chapter of sustainable, profitable, growth," which will be built on a foundation of the Calvin Kline and Tommy Hilfiger brands. The company also said it plans on "supercharging" its e-commerce channel. That actually makes sense in this new world of hybrid workers buying fewer suits and more work-casual clothing. It is also interesting to note that this is the first major move by new CEO (Feb, 2021) Stefan Larsson—though longtime CEO and well-respected industry insider Manny Chirico did take on the role of Chairman of the Board. Not counting Chirico, the average tenure of PVH's management team is just 1.5 years. As for the buyer of these brands, privately-held Authentic is collecting quite the portfolio. In addition to these four names, the company owns Forever 21, Lucky Brand, Nine West, and part of Brooks Brothers—which it helped buy out of bankruptcy last year. Before the pandemic, PVH had an annual revenue of approximately $10 billion and a net income which was perennially in the black. Last year, the firm notched $7 billion in sales and lost $1.16 billion.
We actually like the move by $7.7 billion PVH to sell off these legacy brands, but is the stock a buy? We don't think so. It is estimated that the company will generate $6.73 in earnings per share in FY2022, which is about what it generated in FY2017. The share price ranged from $84 to $139 that year, and we wouldn't touch it above $75 per share. Perhaps the fledgling management team will impress, but this single move is really all we have to go on thus far.
Interactive Media & Services
03. Facebook joins the Trillion Dollar Club after judge throws out the FTC's complaint
Talk about some rarified air: Facebook (FB $356) joined an elite group of companies carrying a market cap of over one trillion dollars after a US District Court judge threw out the antitrust complaints against the company filed by the Federal Trade Commission and virtually all states' attorneys general. That dismissal led to a 4.25% pop in the company's share price, giving it a $1.009 trillion valuation. Facebook joins Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL) in the tiny group of companies which can boast of a $1 trillion size. While Judge James Boasberg disputed the FTC's claim that Facebook was a monopoly, he did leave the door open for the agency to amend its complaint and submit a revised filing. Had it been successful, the complaint could have forced Facebook to divest itself of both the WhatsApp and Instagram platforms. The court seemed to excoriate the plaintiffs' lack of effort, at one point in the ruling saying that the allegations "do not even provide an estimated figure or range for Facebook's market share at any point over the past ten years...." Ouch. It seems as though the judge felt there was some hubris involved in the suit, with an "expectation" that the court would find fault in Facebook's business practices. Arrogance and hubris among government officials? Shocking.
Despite all the bluster among elected officials about cutting these big social media companies down to size, we think very little gets accomplished (to that end) in the near future. As a matter of fact, a 20% investment in each of these five behemoths—beginning today—would probably yield some impressive results if we were to go forward five years in time and gauge the investment bucket's return.
Restaurants
02. Krispy Kreme: Love the doughnuts, hate the stock
More technically, love the doughnuts, hate the financial engineering firm that is bringing the company public...again. Krispy Kreme, former symbol KKD, used to be one of our favorite trading stocks. We actually had a client at A.G. Edwards who would only trade two stocks, KKD and WMT, based on whether the economy was in an expansionary period or a contraction phase. Fast forward to 2016, when KKD was taken private by the powerful German Reimann family, via their JAB Holding Company. JAB had also gobbled up the likes of Peet's Coffee, Panera Bread, Keurig Dr. Pepper, Einstein Bros. Bagels, and a host of other fast food and consumer goods companies. As with all financial engineering firms, the strategy is to make as much money as possible with as little effort as possible, and one popular tactic is the repackaging of companies to bring public once again under a shiny new symbol. That is precisely what JAB did with Krispy Kreme, which now trades under the new—admittedly catchier—symbol DNUT ($19). Perhaps the most insulting aspect of this game of smoke and mirrors is the fact that JAB will retain 78% control of the firm, so suckers...er, investors...beware. Investors did appear to be leery of the game: after planning to offer $26.7 million shares in the range of $21 to $24, soft demand led to the holding company selling 29.4 million shares at $17. While they did rocket up 24% from the offering price on IPO day, the shares steadily declined from there. DNUT shares closed out their first week at $19.12.
We have to wonder how many DNUT investors were aware of the company's back story as opposed to just thinking, "cool, Krispy Kreme is going public and the shares are cheap." They are actually not cheap. In fact, Amazon shares at $3,510 are "cheaper" than DNUT at $19. But none of that seems to matter in these days of meme stocks and SPACs. If shares are $25 or less, it must be a good deal, so let's buy in and watch the confetti fall on our iPhone screen.
Market Week in Review
01. Strong June jobs report leads to weekly gains across the board
All of the major indexes—along with the price of crude—rose over 1% this week on the back of a solid June jobs report. The economy added 850,000 new jobs for the month, and while the unemployment rate ticked up 10 basis points (to 5.9%), that was simply due to more Americans re-entering the job market. Investors actually liked the small uptick, as it lessens the odds of the Fed tightening sooner than expected. In a sign that employers are having a difficult time filling open spots, hourly wages in the private sector rose a robust 3.6% from a year ago. Among the sectors and market caps, big tech names led the week's rally, with the NASDAQ jumping 1.94%. Crude oil rose 1.62% on the week, trading a whopping 55% higher on the year. The first two months of the "worst six months of the year" have come and gone, and we are impressed at how well the markets have held up thus far.
Under the Radar Investment
Kratos Defense & Security Solutions
Kratos Defense & Security Solutions Inc (KTOS $28), despite its small size ($3.7B), is a key player in America's defense and aerospace infrastructure. The company develops and fields advanced systems and platforms for national security and communications needs. Its Skyborg program is focused on expanding the envelope of unmanned aircraft use, especially as related to artificial intelligence; while its Defense and Rocket Support Services (DRSS) division develops hypersonic test vehicles for America's missile defense initiative. Civilian and government satellite operators, meanwhile, rely on Kratos as their strategic supplier of end-to-end enterprise products. We especially like the company's size and financial health, and believe the company will continue along its strong growth trajectory.
Answer
While the battles of Lexington and Concord, which were fought on 19 April 1775, technically kicked off the American Revolution, it was the Battle of Bunker Hill, which was actually fought on Breed's Hill on 17 June 1775, that made both sides in the fight realize there was no turning back. While the British won the battle, it was a Pyrrhic victory: the number of British killed or wounded (1,054, including 89 officers) was over twice that suffered on the American side. The King's troops and their loyalist allies in Boston were left stunned and shocked, while the "loss" served as a rallying cry for the patriots' cause. George Washington, who had been appointed commander of the Continental Army just three days prior, arrived shortly after the conclusion of the battle. Soon, the disparate militias of the various colonies would be forged into one American force.
Headlines for the Week of 13 Jun—19 Jun 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The mighty American economy...
At $22 trillion, the US has—by far—the largest economy in the world. The great growth trajectory began at the end of the Second World War, when the US had an economy of around $240 billion. How long did it take the country's economy to reach $1 trillion in size?
Penn Trading Desk:
Penn: Add a crypto play to the Intrepid
We have made the comparison between the Gold Rush of the mid-19th century and the crypto craze unfolding right now. We have urged investors to "invest in the companies supplying the tools rather than in the miners themselves." Taking our own advice, we just added a cryptocurrency infrastructure play to the Intrepid Trading Platform. Members, sign into the Penn Trading Desk for details.
Goldman: Double downgrade Ferrari
At $205 per share ($210 before the downgrade) and a price-to-earnings ratio of 50, Italian automaker Ferrari (RACE) does seem a bit expensive. Furthermore, its reliance on Formula One racing and its recent drought in that arena could be damaging the brand's reputation. At least that is what Goldman Sachs analyst George Galliers said as part of the rationale for his double downgrade of the company's shares, from Buy to Sell. Galliers, who reduced the Goldman target price on RACE from $227 to $207, also said that the firm is facing higher capital spending as it invests in EV battery technology, with little assurance of its success in that arena.
Penn: Added foreign telecom play to Strategic Income Portfolio
One never knows for certain how any given individual stock will perform going forward, but we found a telecom services company that checks three of our boxes for the Strategic Income Portfolio: a great yield, a foreign play (which we are chronically short on), and a smart strategic vision which embraces the future of the industry. Added to the SIP. Members, sign into the Penn Trading Desk for details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Industrials: Airlines
10. America is entering a new era of supersonic air travel—and Boeing is not building the aircraft
When I was growing up in the 1970s, with an avid fascination in all things air and space, there were dozens of major, publicly-traded, aerospace and defense contractors. Sadly, due to mergers and acquisitions (the largest being Boeing's 1997 purchase of McDonnell Douglas), the numbers dwindled to a few. As competition helps assure that companies continue to operate at peak performance, we knew that the seemingly-endless acquisitions would lead to complacency. And indeed, based on Boeing's (BA $ 250) string of recent high-profile failures, it did. Fortunately, a new breed of young upstarts has entered the industry, and they are fearless when it comes to putting bold plans into action. While SpaceX is the first name that comes to mind, another, lesser-known company is about to make a major splash.
United Airlines Holdings (UAL $57) just announced plans to buy a fleet of 15 supersonic passenger aircraft, capable of traveling at Mach 1.7, from Denver-based Boom Technology. The Boom Overture, which can carry up to 88 passengers and will have a cruising altitude of 60,000 feet, is slated to begin ferrying United passengers by the end of the decade. Using sustainable aviation fuel (SAF), the aircraft is made with advanced composite materials and will be propelled by much quieter—by supersonic standards—Rolls Royce twin engines. It is interesting to note that Boeing CEO, David Calhoun, said that an investment in supersonic travel didn't make sense for his company's business right now.
Currently, United is the only US carrier which has signed an agreement with Boom for the Overture, but Japan Airlines (JAPSY $12) has been a major backer of the US firm, investing $10 million in the company and signing a nonbinding option to buy 20 of the aircraft. Putting the speed of the craft in some context, a flight from New York to London will be reduced in travel time by roughly half: from 6:30H to 3:30H. United CEO Scott Kirby stated that "United continues on its trajectory to build a more innovative, sustainable airline and today's advancements in technology are making it more viable for that to include supersonic planes." Well said.
In the zeitgeist of too many CEOs focused more on "not offending" than on their own strategic visions, we salute Kirby and his leadership. We also salute yet another startup boldly going where the old, established players fear to tread. Perhaps the latter group needs a little history lesson in what made their respective companies great in the first place.
Cryptocurrencies
09. Bitcoin drops following FBI's successful clawback of ransom
It always struck us as odd that so many cryptophiles—the unabashed cheerleaders of all digital "currencies"—consider these creatures completely secure from outside forces. Granted, we have heard stories of Bitcoin owners forgetting their digital wallet passcodes, thus losing their coins forever, but we are talking about something which exists purely in the digital realm. Perhaps that realization hit home for some this week following the FBI's successful recovery of $2.3 million worth of bitcoins paid to the Russian-backed hacker group DarkSide by Colonial Pipeline. The ransom was apparently retrieved after investigators either uncovered the complex key code for the hackers' digital wallet, or somehow took control of the server which held the coins. However it was done, the specter of a third party being able to reach in and take bitcoins out lacking the permission of the wallet's owner sent the price of Bitcoin down around 8%. The FBI recently launched its Ransomware and Digital Extortion Task Force, which was responsible for the recovery. The price of Bitcoin has been reeling as of late, falling from its high of $64,000 in the middle of April to $32,800 following news of the ransom recovery.
As we've mentioned before, anyone wishing to get in on the crypto craze would be better off buying into the underlying blockchain technology rather than amassing the actual coins. Coinbase (COIN $227), the platform on which a number of major cryptos trade, might be a good place to start.
Automotive
08. Two words investors never want to see in an SEC filing
Looking at a company's actual financials can be a great way to spot trends, but we love a more nebulous measure as well: watching a CEO in live interviews. That is how we first got an inkling that the likes of bumbling Ron Johnson (JCP), Bernie Ebbers (WCOM), and Jeffrey Immelt (GE) were either blowing smoke or out of their league—to put it nicely. As we watched interviews of EV startup Lordstown Motors' (RIDE $10) CEO Steve Burns on the business networks, we had an uneasy feeling. He came across as a super-nice guy, but one who was banking on hope, not facts. As the meme stock groupies drove RIDE shares up from the $10 range—where they had languished for years—to $31.40, we shook our heads. Here is a company offering a ton of promises and not one vehicle in production. CNBC's Phil Lebeau pressed Burns on the massive number of pre-orders supposedly on the books, and the response was an embarrassing shuffle that made us grimace.
Fast forward to this week and the company's required quarterly filing; a filing which was submitted late, and only after the threat of a delisting notice from the Nasdaq. There was a lot of disconcerting language in the filing, but investors' jaws dropped on two words nestled in one ugly sentence: "These conditions raise substantial doubt regarding our ability to continue as a going concern for a period of at least one year...." Going concern. That means staying in business. The company came out and admitted that, failing to raise massive new amounts of capital, it would simply cease to be. RIDE shares plunged after hours on the report. At $10 per share once again, and with a major short interest, isn't it time for the WallStreetBets crowd to pile back in and stick it to "the man" yet again?
Such a joke. And emblematic of the ugliness that will soon unfold before our very eyes with a number of other profitless companies. Meme groupie money may staunch the bleeding for awhile, but the inflows only prolong the inevitable. As for Lordstown, we would be surprised if one unit of one product ever leaves the actual assembly line.
Economics
07. Inflation just hit its highest rate since 2008; here's why the Fed isn't worried
The average price of goods purchased by Americans rose 0.6% month-over-month in May, following a 0.8% jump in April. That may not sound like much, but May's Consumer Price Index number equates to a 7.2% annualized rate. The MoM figures represent the fastest rate of inflation since August of 2008. Leading the charge was the price of used cars and trucks, which rose a whopping 7.2% in May on the heels of a double-digit price jump in April.
Why doesn't Jerome Powell's Fed, which has a 2% target inflation range, seem worried by these numbers? One major reason is a phenomenon known as the base effect. Simply put, this condition argues that if inflation was too low in the same period a year earlier, even a small rise in CPI will mathematically show a high current rate of inflation. Indeed, the pandemic put a short-term clamp on economic activity, so it is understandable that the rate of inflation would appear worrisome at the moment. Here's the real question on the mind of economists, however: as we work through this blip, will the rate stabilize or continue to grow?
Another factor to consider is wage growth. Wage push inflation is an overall jump in inflation as a result of companies needing to pay more to their workforce. Evidence of wage push inflation is everywhere, with the latest example coming from Chipotle. The fast casual chain said it must hike menu prices by around 4% to cover the higher cost of paying its employees. By the end of the month, the average hourly wage for employees at the restaurant will hit $15. With a record number of job openings, this condition will certainly gain momentum as companies struggle to find the workers they need to handle the growing demand for their products and services.
While the Fed has indicated it probably won't raise rates until 2023, we expect the central bank to begin signaling a slowdown in its bond buying program at some point in the second half of the year—a very important step to help staunch the unsustainable level of federal spending. The Fed has been buying $120 billion per month worth of treasuries and mortgage-backed securities, leading to its bloated $8 trillion balance sheet. The market should be prepared for this step, but expect at least a short-term fit when the tapering is announced.
Media & Entertainment
06. Yet another reason to avoid GameStop shares: Microsoft is about to make a major gaming push
Not that true investors needed yet another reason to avoid a stock that is overvalued by 90%, but Microsoft's (MSFT $259) announcement that it will bring its Xbox games directly to smart TVs reveals just how antiquated bricks and mortar video game retailers—namely, GameStop (GME $235)—are becoming. Microsoft CEO Satya Nadella's strategy is straightforward: he wants gamers to be able to go from device to device and enjoy an incredible gaming experience, without the need to buy the latest—often outrageously-priced and sold out—gaming equipment. That means developing the cloud-based infrastructure required to efficiently stream Xbox games on computers, hand-held devices, and TVs. The company is already in talks with smart TV makers and streaming device providers like Roku (ROKU $347) to bring the strategy to fruition. The ultimate goal for Microsoft is to increase its Game Pass subscription business, which currently has about 23 million users, giving the company another steady stream of monthly income. If Nadella can replicate the incredible success of Microsoft 365, a subscription-based service for the company's software suite, it will continue to gobble up market share in the world of online gaming. And that spells trouble for an old video game retailer trying to transform itself into a digital player.
We may be dedicated Apple users, but Microsoft remains one of our strongest conviction holdings in the Penn Global Leaders Club. We also happen to be one of the 240 million or so users of Microsoft Office 365, paying the company a steady stream of recurring monthly income so we can operate Microsoft software on our MacBook Pros. We may curse our lonely PC on a weekly basis (some software still doesn't play nice with macOS), but Satya Nadella is one of the best CEOs in corporate America. As for GameStop, we are still waiting for incoming chairman Ryan Cohen's great strategic turnaround plan for GameStop (not).
Aerospace & Defense
05. Northrop Grumman just successfully launched a US Space Force satellite into orbit aboard its Pegasus XL launch vehicle
At 1:11 in the morning, a Northrop Grumman (NOC $371) L-1011 "Stargazer" took off from the newly renamed Vandenberg Space Force Base in California. After achieving 40,000 feet over the Pacific Ocean, its special cargo launched from the underbelly: a solid fuel Pegasus XL rocket carrying a secretive United States Space Force satellite. Last Sunday's launch represented the 45th deployment for the Pegasus, which Northrop Grumman was able to design, integrate, test, and place into service within a whirlwind four month period following the contract award. The rocket, which was built under the USSF's tactically responsive launch concept, is the world's first privately-developed commercial space launch vehicle. It has the ability to launch payloads from virtually anywhere on Earth at a moment's notice and with minimal ground support. The rocket is quickly becoming a favorite tool of the nascent US Space Force.
While Lockheed Martin (LMT $390) is the primary defense contractor within our Penn Global Leaders Club, Northrop Grumman is high on our list of the most respected industry players—easily ahead of Boeing. The $60 billion company (what a great size—well poised to become a $100 billion firm) netted a $3.2 billion profit on $37 billion in revenues last year.
Cryptocurrencies
04. Finally, a crypto that acts like a currency: Tether now the third-largest digital coin in the world
We have laughed off any comparison of cryptocurrencies such as Bitcoin to actual currencies; they are actually commodities with wild volatility. Well, that is true for most of them. All of a sudden, a digital currency known as a stablecoin has roared into third place—behind Bitcoin and Ether—on the list of the world's largest cryptocurrencies. Tether, which was originally known as Realcoin, is—as the name implies—tethered to an actual currency. Tether USDT is tied to the price of a US dollar, EURT to the euro, CHNT to the Chinese yuan, and XAUT to the price of an ounce of gold. So, at least in theory, one Tether USDT will always be worth one US dollar. As one could imagine, that makes it a lot easier for owners to buy goods with their USDTs, as they won't be worried that they could buy the same goods for a lot less in the future (due to fluctuation). The cryptocurrency got a big boost in May when the largest US digital exchange, Coinbase (COIN $232), announced that Tether USDT would be available on its platform. Tether is not without its share of controversy, however. It got in some hot water a few years back by implying that it was fully backed by the dollar. In actuality, a breakdown of the coin's reserves shows that it is 75%-backed by cash and cash equivalents; 13%-backed by secured loans; and 12%-backed by corporate bonds, precious metals, and other digital tokens. Nonetheless, it has traded at or near $1 throughout its seven year history. Another thing we like about this coin: For foreign nationals who don't have access to US bank accounts but want the stability of the US dollar, Tether has proved to be a popular solution.
Tether's market cap surpassed $60 billion last month, and we expect it to maintain its steep growth trajectory. Considering the Communist Party of China is hell-bent on creating a digital currency to supplant the US dollar as the world's reserve currency, perhaps the United States Treasury should study Tether as it slowly prepares to roll out its own fiat digital currency. In the meantime, Tether is one of the only digital coins whose future value we can confidently predict.
Financial Services
03. American Express has a new hybrid work model we can get behind
We have all witnessed how the pandemic has uprooted the traditional work/office relationship in a dramatic fashion. Companies which would never would have considered allowing a meaningful percentage of their workforce to perform their duties at home are suddenly rethinking those policies—and discovering just how much they can save in overhead through a reduced real estate footprint. One of our favorite new hybrid models comes to us from American Express (AXP $158), a global financial services firm operating in 130 countries. Most of the company's US and UK workers will be required to show up at the office just three days a week, Tuesday through Thursday, with the choice to work from home every Monday and Friday. Thinking back on some past jobs, that seems like a dream scenario to us. The new AmEx policy, which will begin this fall, stands in stark contrast to Goldman Sachs' (GS $349) demand that all employees return to the office by the 14th of July. Goldman Sachs CEO David Solomon (of which we have never been a fan) went so far as to call remote work "an aberration," and harmful to productivity. Based on some rather ugly employee feedback over the past few years, neither the company's policy nor the CEO's imperious comments surprise us. In a memo to employees, AmEx CEO Steve Squeri said that the new hybrid model will allow for both in-office collaboration and an increased work-life balance. Between the two firms, we know who we would rather work for.
Goldman Sachs has a notorious history of corporate arrogance. Thanks to technology and a shifting demographic landscape, the company is facing increased competition in areas it used to dominate, such as mergers and acquisition and securities underwriting. Counter that with American Express (granted, not exactly an apples-to-apples comparison), whose strong position within the small business community should provide a nice tailwind going forward.
Pharmaceuticals
02. AstraZeneca has another fail
Precisely one quarter ago we were writing of AstraZeneca's (AZN $58) vaccine fail—due to blood clot complications among some recipients—and management's unswerving denial that there was anything wrong with the drug; even hinting that a political hit job was in play. European countries went from halting the vaccine's use, to (under pressure) resuming its use, to halting it once again. This quarter the Swedish/UK conglomerate is facing yet another setback: its antibody drug is proving to be just 33% effective in preventing symptomatic Covid-19 in those exposed to the virus. Meanwhile, both Regeneron and Eli Lilly each have successful antibody cocktails already in use under emergency authorization. The US had already ordered 700,000 doses of the AstraZeneca therapy for delivery this year, while the UK had ordered one million doses. Odds are strong that the US will ultimately cancel the order, and it will be fascinating to watch what the company's home country ends up doing with respect to the one-million-dose order.
We are constantly on the lookout for strong pharmaceutical stocks and sound international companies in which to invest. Unfortunately, AZN doesn't fit the bill—in our opinion—for either category. Meanwhile, AZN shares are trading as if both therapies were a rousing success.
Market Week in Review
01. In a week to be expected—both based on the calendar and an FOMC meeting—stocks retreat
It wasn't a pretty week for the markets. After all, the Dow lost over 1,000 points (down 3.45%) and the S&P gave up nearly 2%. If there was a "bright spot" it was the tech-laden NASDAQ, which just gave back 28 basis points over the five-day period. We have no problem with the pullback: nothing makes us more nervous than built-in investor expectations for weekly gains. What bothers us is the rationale for the pullback. Investors (apparently) got spooked by the Fed's "more hawkish" tone after the week's FOMC meeting. Hawkish tone? You've got to be kidding. Did Chairman Powell even talk about ending the $120 billion monthly purchase of Treasuries and mortgage-backed securities? Nope. Did the Fed signal an imminent interest rate hike? Nope. St Louis Fed President James Bullard, who will be a voting member of the FOMC next year, said he could see a rate hike coming before 2022 is done. Katy, bar the door! You mean, we might actually move off of a target fed funds rate of zero?! Sure, there is also the fear of inflation running hotter than Powell expects, but we had to hear the word "transitory" at least one hundred times over the course of the week with respect to that particular market threat. In fact, the anemic yield of the 10-year Treasury actually fell this week, showing how little bond investors are worried about inflation forcing the Fed's hand. In all, this was simply a rather welcome pressure relief for a stock market that seemed to forget what a downturn was—despite the nightmare it was emerging from precisely one year ago. We went into the week with the Dow sitting above 34,000; we can handle an 1,190-point giveback. In fact, investors need to be mentally prepared for more summer volatility ahead.
Under the Radar Investment
POSCO
POSCO (PKX $73) is the largest steel producer in South Korea and one of the top steel producers in the world. The company is exposed to the auto, shipbuilding, home appliance, engineering, and machinery industries. The firm controls 40% of the domestic market share and exports roughly 50% of its steel products overseas, primarily to Asian countries. POSCO netted $1.3 billion in profit on $48 billion in revenues last year, and we expect the firm to play a major role in Asia's post-pandemic rebound. We believe the shares, which carry a 3% dividend yield and a P/E ratio of 12, could fetch $100 relatively soon.
Answer
It took just one generation, from the end of World War II to approximately the time we were landing astronauts on the lunar surface in 1969, for the American economy to grow from around $240 billion to $1 trillion—a fourfold increase.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The mighty American economy...
At $22 trillion, the US has—by far—the largest economy in the world. The great growth trajectory began at the end of the Second World War, when the US had an economy of around $240 billion. How long did it take the country's economy to reach $1 trillion in size?
Penn Trading Desk:
Penn: Add a crypto play to the Intrepid
We have made the comparison between the Gold Rush of the mid-19th century and the crypto craze unfolding right now. We have urged investors to "invest in the companies supplying the tools rather than in the miners themselves." Taking our own advice, we just added a cryptocurrency infrastructure play to the Intrepid Trading Platform. Members, sign into the Penn Trading Desk for details.
Goldman: Double downgrade Ferrari
At $205 per share ($210 before the downgrade) and a price-to-earnings ratio of 50, Italian automaker Ferrari (RACE) does seem a bit expensive. Furthermore, its reliance on Formula One racing and its recent drought in that arena could be damaging the brand's reputation. At least that is what Goldman Sachs analyst George Galliers said as part of the rationale for his double downgrade of the company's shares, from Buy to Sell. Galliers, who reduced the Goldman target price on RACE from $227 to $207, also said that the firm is facing higher capital spending as it invests in EV battery technology, with little assurance of its success in that arena.
Penn: Added foreign telecom play to Strategic Income Portfolio
One never knows for certain how any given individual stock will perform going forward, but we found a telecom services company that checks three of our boxes for the Strategic Income Portfolio: a great yield, a foreign play (which we are chronically short on), and a smart strategic vision which embraces the future of the industry. Added to the SIP. Members, sign into the Penn Trading Desk for details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Industrials: Airlines
10. America is entering a new era of supersonic air travel—and Boeing is not building the aircraft
When I was growing up in the 1970s, with an avid fascination in all things air and space, there were dozens of major, publicly-traded, aerospace and defense contractors. Sadly, due to mergers and acquisitions (the largest being Boeing's 1997 purchase of McDonnell Douglas), the numbers dwindled to a few. As competition helps assure that companies continue to operate at peak performance, we knew that the seemingly-endless acquisitions would lead to complacency. And indeed, based on Boeing's (BA $ 250) string of recent high-profile failures, it did. Fortunately, a new breed of young upstarts has entered the industry, and they are fearless when it comes to putting bold plans into action. While SpaceX is the first name that comes to mind, another, lesser-known company is about to make a major splash.
United Airlines Holdings (UAL $57) just announced plans to buy a fleet of 15 supersonic passenger aircraft, capable of traveling at Mach 1.7, from Denver-based Boom Technology. The Boom Overture, which can carry up to 88 passengers and will have a cruising altitude of 60,000 feet, is slated to begin ferrying United passengers by the end of the decade. Using sustainable aviation fuel (SAF), the aircraft is made with advanced composite materials and will be propelled by much quieter—by supersonic standards—Rolls Royce twin engines. It is interesting to note that Boeing CEO, David Calhoun, said that an investment in supersonic travel didn't make sense for his company's business right now.
Currently, United is the only US carrier which has signed an agreement with Boom for the Overture, but Japan Airlines (JAPSY $12) has been a major backer of the US firm, investing $10 million in the company and signing a nonbinding option to buy 20 of the aircraft. Putting the speed of the craft in some context, a flight from New York to London will be reduced in travel time by roughly half: from 6:30H to 3:30H. United CEO Scott Kirby stated that "United continues on its trajectory to build a more innovative, sustainable airline and today's advancements in technology are making it more viable for that to include supersonic planes." Well said.
In the zeitgeist of too many CEOs focused more on "not offending" than on their own strategic visions, we salute Kirby and his leadership. We also salute yet another startup boldly going where the old, established players fear to tread. Perhaps the latter group needs a little history lesson in what made their respective companies great in the first place.
Cryptocurrencies
09. Bitcoin drops following FBI's successful clawback of ransom
It always struck us as odd that so many cryptophiles—the unabashed cheerleaders of all digital "currencies"—consider these creatures completely secure from outside forces. Granted, we have heard stories of Bitcoin owners forgetting their digital wallet passcodes, thus losing their coins forever, but we are talking about something which exists purely in the digital realm. Perhaps that realization hit home for some this week following the FBI's successful recovery of $2.3 million worth of bitcoins paid to the Russian-backed hacker group DarkSide by Colonial Pipeline. The ransom was apparently retrieved after investigators either uncovered the complex key code for the hackers' digital wallet, or somehow took control of the server which held the coins. However it was done, the specter of a third party being able to reach in and take bitcoins out lacking the permission of the wallet's owner sent the price of Bitcoin down around 8%. The FBI recently launched its Ransomware and Digital Extortion Task Force, which was responsible for the recovery. The price of Bitcoin has been reeling as of late, falling from its high of $64,000 in the middle of April to $32,800 following news of the ransom recovery.
As we've mentioned before, anyone wishing to get in on the crypto craze would be better off buying into the underlying blockchain technology rather than amassing the actual coins. Coinbase (COIN $227), the platform on which a number of major cryptos trade, might be a good place to start.
Automotive
08. Two words investors never want to see in an SEC filing
Looking at a company's actual financials can be a great way to spot trends, but we love a more nebulous measure as well: watching a CEO in live interviews. That is how we first got an inkling that the likes of bumbling Ron Johnson (JCP), Bernie Ebbers (WCOM), and Jeffrey Immelt (GE) were either blowing smoke or out of their league—to put it nicely. As we watched interviews of EV startup Lordstown Motors' (RIDE $10) CEO Steve Burns on the business networks, we had an uneasy feeling. He came across as a super-nice guy, but one who was banking on hope, not facts. As the meme stock groupies drove RIDE shares up from the $10 range—where they had languished for years—to $31.40, we shook our heads. Here is a company offering a ton of promises and not one vehicle in production. CNBC's Phil Lebeau pressed Burns on the massive number of pre-orders supposedly on the books, and the response was an embarrassing shuffle that made us grimace.
Fast forward to this week and the company's required quarterly filing; a filing which was submitted late, and only after the threat of a delisting notice from the Nasdaq. There was a lot of disconcerting language in the filing, but investors' jaws dropped on two words nestled in one ugly sentence: "These conditions raise substantial doubt regarding our ability to continue as a going concern for a period of at least one year...." Going concern. That means staying in business. The company came out and admitted that, failing to raise massive new amounts of capital, it would simply cease to be. RIDE shares plunged after hours on the report. At $10 per share once again, and with a major short interest, isn't it time for the WallStreetBets crowd to pile back in and stick it to "the man" yet again?
Such a joke. And emblematic of the ugliness that will soon unfold before our very eyes with a number of other profitless companies. Meme groupie money may staunch the bleeding for awhile, but the inflows only prolong the inevitable. As for Lordstown, we would be surprised if one unit of one product ever leaves the actual assembly line.
Economics
07. Inflation just hit its highest rate since 2008; here's why the Fed isn't worried
The average price of goods purchased by Americans rose 0.6% month-over-month in May, following a 0.8% jump in April. That may not sound like much, but May's Consumer Price Index number equates to a 7.2% annualized rate. The MoM figures represent the fastest rate of inflation since August of 2008. Leading the charge was the price of used cars and trucks, which rose a whopping 7.2% in May on the heels of a double-digit price jump in April.
Why doesn't Jerome Powell's Fed, which has a 2% target inflation range, seem worried by these numbers? One major reason is a phenomenon known as the base effect. Simply put, this condition argues that if inflation was too low in the same period a year earlier, even a small rise in CPI will mathematically show a high current rate of inflation. Indeed, the pandemic put a short-term clamp on economic activity, so it is understandable that the rate of inflation would appear worrisome at the moment. Here's the real question on the mind of economists, however: as we work through this blip, will the rate stabilize or continue to grow?
Another factor to consider is wage growth. Wage push inflation is an overall jump in inflation as a result of companies needing to pay more to their workforce. Evidence of wage push inflation is everywhere, with the latest example coming from Chipotle. The fast casual chain said it must hike menu prices by around 4% to cover the higher cost of paying its employees. By the end of the month, the average hourly wage for employees at the restaurant will hit $15. With a record number of job openings, this condition will certainly gain momentum as companies struggle to find the workers they need to handle the growing demand for their products and services.
While the Fed has indicated it probably won't raise rates until 2023, we expect the central bank to begin signaling a slowdown in its bond buying program at some point in the second half of the year—a very important step to help staunch the unsustainable level of federal spending. The Fed has been buying $120 billion per month worth of treasuries and mortgage-backed securities, leading to its bloated $8 trillion balance sheet. The market should be prepared for this step, but expect at least a short-term fit when the tapering is announced.
Media & Entertainment
06. Yet another reason to avoid GameStop shares: Microsoft is about to make a major gaming push
Not that true investors needed yet another reason to avoid a stock that is overvalued by 90%, but Microsoft's (MSFT $259) announcement that it will bring its Xbox games directly to smart TVs reveals just how antiquated bricks and mortar video game retailers—namely, GameStop (GME $235)—are becoming. Microsoft CEO Satya Nadella's strategy is straightforward: he wants gamers to be able to go from device to device and enjoy an incredible gaming experience, without the need to buy the latest—often outrageously-priced and sold out—gaming equipment. That means developing the cloud-based infrastructure required to efficiently stream Xbox games on computers, hand-held devices, and TVs. The company is already in talks with smart TV makers and streaming device providers like Roku (ROKU $347) to bring the strategy to fruition. The ultimate goal for Microsoft is to increase its Game Pass subscription business, which currently has about 23 million users, giving the company another steady stream of monthly income. If Nadella can replicate the incredible success of Microsoft 365, a subscription-based service for the company's software suite, it will continue to gobble up market share in the world of online gaming. And that spells trouble for an old video game retailer trying to transform itself into a digital player.
We may be dedicated Apple users, but Microsoft remains one of our strongest conviction holdings in the Penn Global Leaders Club. We also happen to be one of the 240 million or so users of Microsoft Office 365, paying the company a steady stream of recurring monthly income so we can operate Microsoft software on our MacBook Pros. We may curse our lonely PC on a weekly basis (some software still doesn't play nice with macOS), but Satya Nadella is one of the best CEOs in corporate America. As for GameStop, we are still waiting for incoming chairman Ryan Cohen's great strategic turnaround plan for GameStop (not).
Aerospace & Defense
05. Northrop Grumman just successfully launched a US Space Force satellite into orbit aboard its Pegasus XL launch vehicle
At 1:11 in the morning, a Northrop Grumman (NOC $371) L-1011 "Stargazer" took off from the newly renamed Vandenberg Space Force Base in California. After achieving 40,000 feet over the Pacific Ocean, its special cargo launched from the underbelly: a solid fuel Pegasus XL rocket carrying a secretive United States Space Force satellite. Last Sunday's launch represented the 45th deployment for the Pegasus, which Northrop Grumman was able to design, integrate, test, and place into service within a whirlwind four month period following the contract award. The rocket, which was built under the USSF's tactically responsive launch concept, is the world's first privately-developed commercial space launch vehicle. It has the ability to launch payloads from virtually anywhere on Earth at a moment's notice and with minimal ground support. The rocket is quickly becoming a favorite tool of the nascent US Space Force.
While Lockheed Martin (LMT $390) is the primary defense contractor within our Penn Global Leaders Club, Northrop Grumman is high on our list of the most respected industry players—easily ahead of Boeing. The $60 billion company (what a great size—well poised to become a $100 billion firm) netted a $3.2 billion profit on $37 billion in revenues last year.
Cryptocurrencies
04. Finally, a crypto that acts like a currency: Tether now the third-largest digital coin in the world
We have laughed off any comparison of cryptocurrencies such as Bitcoin to actual currencies; they are actually commodities with wild volatility. Well, that is true for most of them. All of a sudden, a digital currency known as a stablecoin has roared into third place—behind Bitcoin and Ether—on the list of the world's largest cryptocurrencies. Tether, which was originally known as Realcoin, is—as the name implies—tethered to an actual currency. Tether USDT is tied to the price of a US dollar, EURT to the euro, CHNT to the Chinese yuan, and XAUT to the price of an ounce of gold. So, at least in theory, one Tether USDT will always be worth one US dollar. As one could imagine, that makes it a lot easier for owners to buy goods with their USDTs, as they won't be worried that they could buy the same goods for a lot less in the future (due to fluctuation). The cryptocurrency got a big boost in May when the largest US digital exchange, Coinbase (COIN $232), announced that Tether USDT would be available on its platform. Tether is not without its share of controversy, however. It got in some hot water a few years back by implying that it was fully backed by the dollar. In actuality, a breakdown of the coin's reserves shows that it is 75%-backed by cash and cash equivalents; 13%-backed by secured loans; and 12%-backed by corporate bonds, precious metals, and other digital tokens. Nonetheless, it has traded at or near $1 throughout its seven year history. Another thing we like about this coin: For foreign nationals who don't have access to US bank accounts but want the stability of the US dollar, Tether has proved to be a popular solution.
Tether's market cap surpassed $60 billion last month, and we expect it to maintain its steep growth trajectory. Considering the Communist Party of China is hell-bent on creating a digital currency to supplant the US dollar as the world's reserve currency, perhaps the United States Treasury should study Tether as it slowly prepares to roll out its own fiat digital currency. In the meantime, Tether is one of the only digital coins whose future value we can confidently predict.
Financial Services
03. American Express has a new hybrid work model we can get behind
We have all witnessed how the pandemic has uprooted the traditional work/office relationship in a dramatic fashion. Companies which would never would have considered allowing a meaningful percentage of their workforce to perform their duties at home are suddenly rethinking those policies—and discovering just how much they can save in overhead through a reduced real estate footprint. One of our favorite new hybrid models comes to us from American Express (AXP $158), a global financial services firm operating in 130 countries. Most of the company's US and UK workers will be required to show up at the office just three days a week, Tuesday through Thursday, with the choice to work from home every Monday and Friday. Thinking back on some past jobs, that seems like a dream scenario to us. The new AmEx policy, which will begin this fall, stands in stark contrast to Goldman Sachs' (GS $349) demand that all employees return to the office by the 14th of July. Goldman Sachs CEO David Solomon (of which we have never been a fan) went so far as to call remote work "an aberration," and harmful to productivity. Based on some rather ugly employee feedback over the past few years, neither the company's policy nor the CEO's imperious comments surprise us. In a memo to employees, AmEx CEO Steve Squeri said that the new hybrid model will allow for both in-office collaboration and an increased work-life balance. Between the two firms, we know who we would rather work for.
Goldman Sachs has a notorious history of corporate arrogance. Thanks to technology and a shifting demographic landscape, the company is facing increased competition in areas it used to dominate, such as mergers and acquisition and securities underwriting. Counter that with American Express (granted, not exactly an apples-to-apples comparison), whose strong position within the small business community should provide a nice tailwind going forward.
Pharmaceuticals
02. AstraZeneca has another fail
Precisely one quarter ago we were writing of AstraZeneca's (AZN $58) vaccine fail—due to blood clot complications among some recipients—and management's unswerving denial that there was anything wrong with the drug; even hinting that a political hit job was in play. European countries went from halting the vaccine's use, to (under pressure) resuming its use, to halting it once again. This quarter the Swedish/UK conglomerate is facing yet another setback: its antibody drug is proving to be just 33% effective in preventing symptomatic Covid-19 in those exposed to the virus. Meanwhile, both Regeneron and Eli Lilly each have successful antibody cocktails already in use under emergency authorization. The US had already ordered 700,000 doses of the AstraZeneca therapy for delivery this year, while the UK had ordered one million doses. Odds are strong that the US will ultimately cancel the order, and it will be fascinating to watch what the company's home country ends up doing with respect to the one-million-dose order.
We are constantly on the lookout for strong pharmaceutical stocks and sound international companies in which to invest. Unfortunately, AZN doesn't fit the bill—in our opinion—for either category. Meanwhile, AZN shares are trading as if both therapies were a rousing success.
Market Week in Review
01. In a week to be expected—both based on the calendar and an FOMC meeting—stocks retreat
It wasn't a pretty week for the markets. After all, the Dow lost over 1,000 points (down 3.45%) and the S&P gave up nearly 2%. If there was a "bright spot" it was the tech-laden NASDAQ, which just gave back 28 basis points over the five-day period. We have no problem with the pullback: nothing makes us more nervous than built-in investor expectations for weekly gains. What bothers us is the rationale for the pullback. Investors (apparently) got spooked by the Fed's "more hawkish" tone after the week's FOMC meeting. Hawkish tone? You've got to be kidding. Did Chairman Powell even talk about ending the $120 billion monthly purchase of Treasuries and mortgage-backed securities? Nope. Did the Fed signal an imminent interest rate hike? Nope. St Louis Fed President James Bullard, who will be a voting member of the FOMC next year, said he could see a rate hike coming before 2022 is done. Katy, bar the door! You mean, we might actually move off of a target fed funds rate of zero?! Sure, there is also the fear of inflation running hotter than Powell expects, but we had to hear the word "transitory" at least one hundred times over the course of the week with respect to that particular market threat. In fact, the anemic yield of the 10-year Treasury actually fell this week, showing how little bond investors are worried about inflation forcing the Fed's hand. In all, this was simply a rather welcome pressure relief for a stock market that seemed to forget what a downturn was—despite the nightmare it was emerging from precisely one year ago. We went into the week with the Dow sitting above 34,000; we can handle an 1,190-point giveback. In fact, investors need to be mentally prepared for more summer volatility ahead.
Under the Radar Investment
POSCO
POSCO (PKX $73) is the largest steel producer in South Korea and one of the top steel producers in the world. The company is exposed to the auto, shipbuilding, home appliance, engineering, and machinery industries. The firm controls 40% of the domestic market share and exports roughly 50% of its steel products overseas, primarily to Asian countries. POSCO netted $1.3 billion in profit on $48 billion in revenues last year, and we expect the firm to play a major role in Asia's post-pandemic rebound. We believe the shares, which carry a 3% dividend yield and a P/E ratio of 12, could fetch $100 relatively soon.
Answer
It took just one generation, from the end of World War II to approximately the time we were landing astronauts on the lunar surface in 1969, for the American economy to grow from around $240 billion to $1 trillion—a fourfold increase.
Headlines for the Week of 23 May—29 May 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The growing power of the plant-based food industry...
The plant-based food business is red-hot, and don't expect it to cool anytime soon. It is not a novelty or a niche corner of the market; it is quickly becoming a mainstream staple. For evidence of that, just look at the growing space dedicated to the products in your local supermarket. What is the size of this industry, based on revenue, and how rapidly did it grow last year over 2019?
Penn Trading Desk:
Penn: AT&T Stopped Out in Strategic Income Portfolio
AT&T CEO John Stankey, earlier this spring: "HBO Max is a pillar of the company's long-term strategy." This week: HBO Max is being spun-off so the company can focus on its "core competencies" of wireless and broadband. What a joke. We placed a stop on T @ $32, and it filled the same day, 17 May, at $31.98. A position we have held since 2010 is officially gone.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. AT&T and Discovery to combine media assets, creating a new entertainment behemoth (i.e., AT&T admits defeat)
While we have owned telecom services giant AT&T (T $33) for years, either in the Penn Global Leaders Club or—most recently—in the Strategic Income Portfolio (it carries a 6.5% dividend yield), we've had a strong sense as of late that the company is not quite sure of its own strategic vision. After all, T bought DirecTV in 2015 for $67 billion (with debt) only to spin it off six years later for one-fourth of that value; and it paid $85 billion to acquire Time Warner a few years after the DirecTV deal only, now, to spin that company off for $43 billion. Someone needs to explain the concept of "buy low and sell high" to the AT&T board.
With respect to the latter, AT&T and Discovery (DISCA $38) have announced plans to combine their media assets, which include the likes of HBO Max, CNN, TBS, Warner Brothers, TLC, and HGTV, into a new publicly-traded company—name to be determined. T shareholders will own 71% of the new entity, with Discovery shareholders getting the remaining 29%. Well-known media executive David Zaslav, current CEO of Discovery, will lead the new business. While Zaslav envisions the new firm becoming the dominant streaming service in the world (Netflix might disagree with that boast), here's what won't be said: this move represents a 180-degree turn for AT&T, which is now throwing in the towel on its lofty media aspirations. Going forward, the company will focus on its 5G buildout and its broadband service. The $43 billion will certainly help the firm pay for the $23 billion worth of 5G spectrum it committed to buying in its bidding war with Verizon (VZ $59). As for that 6.5% dividend yield which has kept many investors around, it will almost certainly be cut when this deal closes.
AT&T popped over 4% on news of this spinoff, jumping to over $33 per share. We know the dividend is going to get cut, and we question how much growth can be squeezed out of the wireless and broadband businesses—considering the fierce competition—over the coming years. We also feel like we got suckered into believing the company's line about creating a new media empire. We are placing a stop on our T position at $32. In short, we have lost almost all confidence in T's management team. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss.
Restaurants
09. Dine Brands' restaurant IHOP to launch fast-casual spinoff Flip'd this summer
It was a plan put on hold due to the pandemic, but Dine Brands' (DIN $95) restaurant IHOP is finally ready to unveil its new fast-casual chain known as Flip'd. The concept is simple: lure on-the-go customers who want to grab some good food fast. Visitors will be able to order the likes of signature pancake bowls, made-to-order egg sandwiches, and a host of other pastry, drink, and food items at either a digital kiosk or the counter, generally taking their food to go. Picture a Chipotle, but breakfast-based. All of the Flip'd locations will be franchise-owned, with IHOP offering $150,000 to each of the first ten franchisees to get them up and running. A few of the very first Flip'd restaurants will be located in Manhattan; Lawrence, Kansas; and several cities in Ohio. A number of restaurants have tried to launch spin-off versions of themselves with a unique twist, but most have had limited success. We will go ahead and predict it: Flip'd will be an overwhelming success.
IHOP is owned by Dine Brands, which also owns Applebee's. Dine was under an enormous amount of financial stress during the pandemic, as could be imagined. While we picked up hotel chains, retail stores, an airline, and even a major gambling resort precisely twelve months ago during the heat of the market free-fall, we didn't pick up any restaurants. That was a mistake: Dine Brands is up 132% since then. Fair value would probably be in the $125 per share range.
Media & Entertainment
08. Amazon poised to make its second-largest acquisition ever: a storied movie studio
Formed in 1924, MGM dominated Hollywood for over a generation. While the studio has had a number of interesting owners over the past century, none have been quite like its next probable owner: Internet retailer Amazon (AMZN $3,245). Back in 2017, when reports surfaced that Amazon was about to buy food retailer Whole Foods for $13.7 billion, there were many of doubters. We believed the move was brilliant, and that opinion has been borne out in an impressively short period of time (Whole Foods now delivers food to the doorstep of Prime members with Amazon-like efficiency). The Whole Foods acquisition remains the company's largest to date; but, with its reported $8.45 billion price tag, MGM will easily hold the second position.
Amazon has been investing heavily in its streaming service, recently inking a deal with the NFL to stream Thursday night games for around $1.2 billion per year. The recent merger of AT&T's Warner Media with Discovery may well have been the catalyst for MGM and the retailer to get this deal inked. It is interesting to note that MGM's former CEO, Gary Barber, was fired by the board after he reportedly engaged in talks with Apple surrounding a possible $6 billion deal. So, with a cost 40% higher than the purported range during the Apple talks, is Amazon overpaying for this asset? Probably. But in the end, they will make the premium look like chump change.
Amazon is a long-standing member of the Penn Global Leaders Club, and we have a fair value on the shares of around $4,250. The most concerning aspect of the company's growth trajectory revolves around government intervention. The company already had a target on its back from an antitrust standpoint; this will only add fuel to the fire of those who wish to see it forcibly broken up.
Food Products
07. Swedish oat milk company Oatly comes out of the gate hot, but established food players are stepping up the pressure
It's an age old story: established players bash a new concept, consumers embrace the new products, and the established players suddenly enter the fray, claiming they were always on board. EVs are perhaps the best example of this, and we remember the Fords and GMs of the world impugning Tesla on a chronic basis...until they suddenly embraced EVs as if it were their idea in the first place. The same is true in the plant-based foods business. Oatly Group AB (OTLY $21), maker of the happy little cartons of "milk" you have probably seen in the dairy section of the grocery store, went public last week. Despite the IPO price of $17, shares shot out of the gate, jumping 37%—to $23.25—within a day. While they have cooled off a bit since, their $21 price still values the company at $12.5 billion—about 50% larger than our favorite plant-based company, Beyond Meat (BYND $123). At $21, are the new shares worth picking up? Plant-based food sales rose an impressive 27%—to $7 billion—in 2020, and the upward trajectory will continue. Silk, which is now owned by Danone (DANOY $15), will probably be the company's chief competitor going forward, but we see Oatly growing its rather faithful consumer base. While it will be a few years before the company is profitable (it lost $60 million in 2020), its revenues doubled last year from the previous year. If shares go below $20, they are worth looking at for investors needing an international play in the consumer staples sector (which you probably do).
We believe a lot of investors are not fully grasping just how big the plant-based food movement will become over the next decade. Consider this frontier investing: there will be massive gains to be had, but choose your vehicles carefully. Oatly is a pretty safe bet.
Pharmaceuticals
06. Just another example of why this company is underrated: Pfizer's Covid pill should be out by year's end
By definition, we believe in all 100 or so investments within the five Penn Wealth strategies; put another way, if we lose faith, we have no qualms jettisoning any of them. That said, at any particular point in time we have our favorites. Typically, these are companies in which we see something dynamic going on, but ones that seem to be flying under the radar of the Street. Penn Global Leaders Club member Pfizer (PFE $38) is a perfect example. We believe this company, which also happens to have a fat 4% dividend yield, is the global benchmark for the pharmaceuticals industry. As if it weren't enough that Pfizer has the most effective vaccine for Covid on the market (which it developed in record time), it now plans to have a pill for the treatment of the deadly virus on the market before the end of the year. Currently in a phase 1 clinical trial, this protease inhibitor (a protease is an enzyme which allows the virus to break down proteins so it can make copies of itself and multiply) could be taken at home by those having positive test results, effectively treating the disease and helping to keep patients out of the hospital. The first protease inhibitor was approved by the FDA a generation ago to treat HIV. As for the various strains of the disease, Pfizer believes the therapy, currently known simply as PF-07321332, should effectively tackle all of them with strong efficacy.
Pfizer has a healthy balance sheet, a strong drug pipeline, a top-tier sales force, and a simply great R&D team. Let others follow meme stocks that are infinitesimally overvalued (i.e., really worth nothing), we will stick with beautiful workhorses like Pfizer. When the next correction comes, washing the silliness away, this 172-year-old stalwart will still be standing.
Global Trade
05. Parity must be the US goal with respect to trade with China
The press keeps telling us that China is about to reach economic parity with the United States, so here's our question to the collective press: why are we importing over four times as much from China as we export to China? If the economies are of equal scale, shouldn't our trade deficit with the communist nation be relatively balanced? In reality, the United States has a $22 trillion economy compared to China's $15 trillion or so, meaning we could even accept a 50% differential in the transfer of goods; but 400%? Something doesn't smell right.
In March, the most recent month on record, we exported $11.27 billion worth of goods to China and imported $48.21 billion worth of goods from China. While those figures are both depressing and outrageous, there is some good news: the US tariffs on Chinese goods are finally forcing US companies to look elsewhere for their purchases. One of the biggest beneficiaries in this shift has been Vietnam, which is now the eighth-largest exporter to the US, moving ahead of India. Vietnam, as we have noted in the past, is no friend to China, with the ongoing South China Sea dispute just the latest bone of contention between the two. The peak in our level of imports from China was $539 billion in 2018; as of the trailing twelve months (TTM) ended 31 March, that figure has dropped to $472 billion. A 12% drop doesn't sound like much, and the pandemic certainly skewed the results to some extent, but at least the needle is moving in the right direction.
Fortunately, the Biden administration has shown little inclination toward removing the tariffs on Chinese goods, much to the consternation of the CPC. Americans must keep up the pressure on companies to persuade them to look elsewhere for the wholesale purchase of products and building of new plants. If that pressure continues, China's five-year plan to overtake the US economically will face a much larger hurdle—despite the cheerleading from much of the press.
Technology is going to be, far and away, our greatest ally in the fight to curb Chinese imports. From 3D printing to vastly increased efficiency for manufacturing firms, technology is the great disruptor with respect to the balance of trade. Investors should keep a close eye on opportunities in the small- and mid-cap industrials space, those tech-heavy firms which almost always travel under the radar. We will continue to highlight individual names for readers.
Global Strategy: Europe
04. America is roaring out of the pandemic; that is not so much the case in Europe
Over the course of the last two quarters, covering the end of 2020 and the beginning of 2021, the US economy grew at an impressive clip of 4.3% and 6.4%, respectively, thanks to a herculean vaccination effort and a subsequent loosening of Covid restrictions. Sadly, this has not been the case across the pond. The latest metric comes from France, which just re-entered a recession. The French economy shrank by 0.1% in the first quarter of 2021, following a 1.5% contraction in Q4 of 2020. But Europe's second-largest economy has some good company: Germany, the eurozone's largest economy, has seen its economy shrink for five straight quarters, with Q1 GDP coming in at -3.10%. To be sure, the pandemic and a chaotic subsequent vaccine rollout have been the catalysts for the recession that Europe can't seem to shake, but there were other factors which prepared the field for these conditions.
While US deficit spending has been a sad, running joke for a number of years, Europe's fiscal policy almost makes America's economic house look enviable. After the Great Recession, Brussels, led by the erudite wonks primarily from France and Germany, spent with reckless abandon to help the poorer nations in the southern region shake off record levels of unemployment—like 28% in Greece and 26% in Spain. Austerity measures were then forced upon these borrowers which only served to exacerbate the problem and create resentment among the citizens of these beleaguered southern nations. Going into the pandemic, unemployment levels remained stubbornly high in Portugal, Italy, Greece, and Spain. In essence, the eurozone never shook off the effects of the 2008-2009 crisis when the global pandemic hit. The ECB's only answer seems to be throwing more money at the problem until it goes away. Eventually, Europe's vaccination rate will subdue the nightmarish pandemic and growth will return to the region. But the economic scars caused by the handling of two massive crises will remain, as will the bitter divide between the northern and southern regions of the continent.
We continue to underweight the eurozone—with the exception of a few emerging markets in Eastern Europe—as the region grapples with its reopening efforts. The UK is the wild card, as the 2017 Brexit outcome appears more and more prescient with each passing month. Goldman Sachs recently issued a glowing outlook for the British economy, anticipating a "striking" 7.8% GDP growth rate for the year. One way to play the anticipated rebound is with the iShares MSCI United Kingdom ETF (EWU $34), which holds 88 large-cap positions; names such as Unilever PLC and London Stock Exchange Group PLC. For investors looking for more growth potential there is the iShares MSCI United Kingdom Small-Cap ETF (EWUS $50), which holds several hundred small- and mid-cap names.
Road & Rail
03. The latest developments in the Kansas City Southern saga
When Canadian National Railway (CNI $113) stunned the industry with its $30 billion bid for Kansas City Southern (KSU $298), we fully expected rival Canadian Pacific Railway (CP $81) to up its prior $25 billion bid. Instead, the rail—which arguably needs the American north-south tracks of KSC more than Canadian National—stuck by its original offer. It also sent a message to Kansas City Southern: take our deal or lose the regulatory battle in the US. The Kansas City-based rail responded by telling Canadian Pacific to take a hike—and eat the $700 million deal breakup fee. At the heart of the issue are overlapping routes (Canadian National Railway has more) and stricter merger standards adopted in 2001 by the Surface Transportation Board (STB). The agency, which must approve or deny the merger, now states that railway mergers must be in the public interest; the older standard simply stated that a deal must not hinder competition. Canadian Pacific's plans? Wait out the ruling, which it expects to be negative, then swoop back in with its original deal.
This is a really tough call, as we see a 50/50 chance for ultimate approval by the STB. In the meantime, KSC seems too expensive (its price has risen to within 9% of the acquisition offer price), we don't like Canadian Pacific's tactics (and it seems fairly valued), and Canadian National will probably take a share price hit if the deal is shot down. That being said, we do like Canadian National's reach, which extends throughout Canada and all the way south to the Mexican border. It agreed to sell some of its southern-most lines to acquire KSC, but that would be a moot point if the deal fails. Of the major rails, CNI at $112.57 seems like the best bet right now for investors.
Biotechnology
02. In the war against Alzheimer's, a momentous day is coming
After a 12-month span in which most well-known health care stocks notched some impressive gains, one well-respected drug manufacturer seems to have been left behind. Biogen (BIIB $267), which has a solid bench of proven performers—like Tysabri for MS and Rituxan for cancer—and a decent pipeline of new therapies, is down 12.90% over the course of the past year. Something big is about to happen, however, that will (probably) move the shares sharply one way or the other, and send a critically-important signal on where we stand in the fight against Alzheimer's. Next Monday, the 7th of June, the US Food and Drug Administration will decide whether or not to approve the use of Biogen's Alzheimer's therapy, aducanumab. It is not just Biogen which will be watching the decision closely, it is also the families of the over six million sufferers of this terrible disease. Considering it has been nearly twenty years since an Alzheimer's therapy has been approved, a positive ruling would be an enormous win against what has been a very elusive disease.
There have been some oddly positive indicators that this drug will finally win approval, such as the very unique step of the FDA preparing a briefing document alongside Biogen on aducanumab. The stakes are high: generics have been slowly eating away at the company's anchor drugs, while approval of this Alzheimer's therapy would add immensely to the company's sales outlook for years to come. Our best guess? Investors should consider buying some shares at their current price of $267 in anticipation of a huge win.
Market Week in Review
01. In a stunning turnaround, two of the three major indexes actually cobbled together a positive May
It wasn't looking very good a few weeks into the new month. In fact, the "Sell in May..." adage seemed destined to, once again, prove true. However, after hammering out a solid second half of the month, both the S&P 500 and the Dow Jones Industrial Average ended May in the green—though not by much. While the NASDAQ couldn't make that happen, it did end up paring its earlier losses, finishing down just 1.53% on the month. Inflation fears seemed to grip the stock market in the first two weeks of May, while plenty of expert witnesses helped to effectively allay those fears during the second half of the month. For crypto investors, the story was more dour. Bitcoin lost one-third of its value in May. Bring on the dog days of summer, and strap in for a wild ride.
Under the Radar Investment
Kongsberg Gruppen ASA (NSKFF $25)
Kongsberg Gruppen ASA is a $4.5 billion Norwegian mid-cap industrials firm (try and find one of those in your portfolio). The company operates primarily in the Maritime and the Aerospace & Defense industries. The company's maritime unit makes navigation, automation, and positioning products for commercial ships and offshore industries. The aerospace unit provides an array of defense- and space-related products and services. Kongsberg has perennially-positive cash flow and a sound balance sheet. The company, which was founded in 1814, is based out of the Buskerud region of Norway.
Answer
According to the food industry publication Supermarket News, in 2018 US plant-based food sales sat at an impressive $4.5 billion. A year later, that figure grew to $5 billion—an 11% YoY growth rate compared to the 2.2% growth rate in total US retail food sales. In 2020, sales in the industry surged a whopping 27%, to $7 billion. Granted, overall retail food sales rose 15% (to $760 billion) due to closed restaurants and lockdowns, but to nearly double that rate says a lot about shifting dietary habits in the country. (And no, we are not knocking the summer delight that is a sizzling T-bone on the grill; it will be some time before that experience can be replicated.) 2021's figures, when they come out next April, will be a fascinating dot to add to the chart, as the lockdowns are essentially over in this country. What do we expect? Another surprisingly-high growth rate.*
*Granted, at 0.92% of overall food sales, the plant-based industry may seem like an afterthought from a sales standpoint. However, to us it simply portrays how much room the industry has to grow. Food products used to be a relatively boring corner of the consumer staples sector; thanks to visionaries like Beyond Meat's Ethan Brown, that is no longer the case...and we love it.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The growing power of the plant-based food industry...
The plant-based food business is red-hot, and don't expect it to cool anytime soon. It is not a novelty or a niche corner of the market; it is quickly becoming a mainstream staple. For evidence of that, just look at the growing space dedicated to the products in your local supermarket. What is the size of this industry, based on revenue, and how rapidly did it grow last year over 2019?
Penn Trading Desk:
Penn: AT&T Stopped Out in Strategic Income Portfolio
AT&T CEO John Stankey, earlier this spring: "HBO Max is a pillar of the company's long-term strategy." This week: HBO Max is being spun-off so the company can focus on its "core competencies" of wireless and broadband. What a joke. We placed a stop on T @ $32, and it filled the same day, 17 May, at $31.98. A position we have held since 2010 is officially gone.
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Media & Entertainment
10. AT&T and Discovery to combine media assets, creating a new entertainment behemoth (i.e., AT&T admits defeat)
While we have owned telecom services giant AT&T (T $33) for years, either in the Penn Global Leaders Club or—most recently—in the Strategic Income Portfolio (it carries a 6.5% dividend yield), we've had a strong sense as of late that the company is not quite sure of its own strategic vision. After all, T bought DirecTV in 2015 for $67 billion (with debt) only to spin it off six years later for one-fourth of that value; and it paid $85 billion to acquire Time Warner a few years after the DirecTV deal only, now, to spin that company off for $43 billion. Someone needs to explain the concept of "buy low and sell high" to the AT&T board.
With respect to the latter, AT&T and Discovery (DISCA $38) have announced plans to combine their media assets, which include the likes of HBO Max, CNN, TBS, Warner Brothers, TLC, and HGTV, into a new publicly-traded company—name to be determined. T shareholders will own 71% of the new entity, with Discovery shareholders getting the remaining 29%. Well-known media executive David Zaslav, current CEO of Discovery, will lead the new business. While Zaslav envisions the new firm becoming the dominant streaming service in the world (Netflix might disagree with that boast), here's what won't be said: this move represents a 180-degree turn for AT&T, which is now throwing in the towel on its lofty media aspirations. Going forward, the company will focus on its 5G buildout and its broadband service. The $43 billion will certainly help the firm pay for the $23 billion worth of 5G spectrum it committed to buying in its bidding war with Verizon (VZ $59). As for that 6.5% dividend yield which has kept many investors around, it will almost certainly be cut when this deal closes.
AT&T popped over 4% on news of this spinoff, jumping to over $33 per share. We know the dividend is going to get cut, and we question how much growth can be squeezed out of the wireless and broadband businesses—considering the fierce competition—over the coming years. We also feel like we got suckered into believing the company's line about creating a new media empire. We are placing a stop on our T position at $32. In short, we have lost almost all confidence in T's management team. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss.
Restaurants
09. Dine Brands' restaurant IHOP to launch fast-casual spinoff Flip'd this summer
It was a plan put on hold due to the pandemic, but Dine Brands' (DIN $95) restaurant IHOP is finally ready to unveil its new fast-casual chain known as Flip'd. The concept is simple: lure on-the-go customers who want to grab some good food fast. Visitors will be able to order the likes of signature pancake bowls, made-to-order egg sandwiches, and a host of other pastry, drink, and food items at either a digital kiosk or the counter, generally taking their food to go. Picture a Chipotle, but breakfast-based. All of the Flip'd locations will be franchise-owned, with IHOP offering $150,000 to each of the first ten franchisees to get them up and running. A few of the very first Flip'd restaurants will be located in Manhattan; Lawrence, Kansas; and several cities in Ohio. A number of restaurants have tried to launch spin-off versions of themselves with a unique twist, but most have had limited success. We will go ahead and predict it: Flip'd will be an overwhelming success.
IHOP is owned by Dine Brands, which also owns Applebee's. Dine was under an enormous amount of financial stress during the pandemic, as could be imagined. While we picked up hotel chains, retail stores, an airline, and even a major gambling resort precisely twelve months ago during the heat of the market free-fall, we didn't pick up any restaurants. That was a mistake: Dine Brands is up 132% since then. Fair value would probably be in the $125 per share range.
Media & Entertainment
08. Amazon poised to make its second-largest acquisition ever: a storied movie studio
Formed in 1924, MGM dominated Hollywood for over a generation. While the studio has had a number of interesting owners over the past century, none have been quite like its next probable owner: Internet retailer Amazon (AMZN $3,245). Back in 2017, when reports surfaced that Amazon was about to buy food retailer Whole Foods for $13.7 billion, there were many of doubters. We believed the move was brilliant, and that opinion has been borne out in an impressively short period of time (Whole Foods now delivers food to the doorstep of Prime members with Amazon-like efficiency). The Whole Foods acquisition remains the company's largest to date; but, with its reported $8.45 billion price tag, MGM will easily hold the second position.
Amazon has been investing heavily in its streaming service, recently inking a deal with the NFL to stream Thursday night games for around $1.2 billion per year. The recent merger of AT&T's Warner Media with Discovery may well have been the catalyst for MGM and the retailer to get this deal inked. It is interesting to note that MGM's former CEO, Gary Barber, was fired by the board after he reportedly engaged in talks with Apple surrounding a possible $6 billion deal. So, with a cost 40% higher than the purported range during the Apple talks, is Amazon overpaying for this asset? Probably. But in the end, they will make the premium look like chump change.
Amazon is a long-standing member of the Penn Global Leaders Club, and we have a fair value on the shares of around $4,250. The most concerning aspect of the company's growth trajectory revolves around government intervention. The company already had a target on its back from an antitrust standpoint; this will only add fuel to the fire of those who wish to see it forcibly broken up.
Food Products
07. Swedish oat milk company Oatly comes out of the gate hot, but established food players are stepping up the pressure
It's an age old story: established players bash a new concept, consumers embrace the new products, and the established players suddenly enter the fray, claiming they were always on board. EVs are perhaps the best example of this, and we remember the Fords and GMs of the world impugning Tesla on a chronic basis...until they suddenly embraced EVs as if it were their idea in the first place. The same is true in the plant-based foods business. Oatly Group AB (OTLY $21), maker of the happy little cartons of "milk" you have probably seen in the dairy section of the grocery store, went public last week. Despite the IPO price of $17, shares shot out of the gate, jumping 37%—to $23.25—within a day. While they have cooled off a bit since, their $21 price still values the company at $12.5 billion—about 50% larger than our favorite plant-based company, Beyond Meat (BYND $123). At $21, are the new shares worth picking up? Plant-based food sales rose an impressive 27%—to $7 billion—in 2020, and the upward trajectory will continue. Silk, which is now owned by Danone (DANOY $15), will probably be the company's chief competitor going forward, but we see Oatly growing its rather faithful consumer base. While it will be a few years before the company is profitable (it lost $60 million in 2020), its revenues doubled last year from the previous year. If shares go below $20, they are worth looking at for investors needing an international play in the consumer staples sector (which you probably do).
We believe a lot of investors are not fully grasping just how big the plant-based food movement will become over the next decade. Consider this frontier investing: there will be massive gains to be had, but choose your vehicles carefully. Oatly is a pretty safe bet.
Pharmaceuticals
06. Just another example of why this company is underrated: Pfizer's Covid pill should be out by year's end
By definition, we believe in all 100 or so investments within the five Penn Wealth strategies; put another way, if we lose faith, we have no qualms jettisoning any of them. That said, at any particular point in time we have our favorites. Typically, these are companies in which we see something dynamic going on, but ones that seem to be flying under the radar of the Street. Penn Global Leaders Club member Pfizer (PFE $38) is a perfect example. We believe this company, which also happens to have a fat 4% dividend yield, is the global benchmark for the pharmaceuticals industry. As if it weren't enough that Pfizer has the most effective vaccine for Covid on the market (which it developed in record time), it now plans to have a pill for the treatment of the deadly virus on the market before the end of the year. Currently in a phase 1 clinical trial, this protease inhibitor (a protease is an enzyme which allows the virus to break down proteins so it can make copies of itself and multiply) could be taken at home by those having positive test results, effectively treating the disease and helping to keep patients out of the hospital. The first protease inhibitor was approved by the FDA a generation ago to treat HIV. As for the various strains of the disease, Pfizer believes the therapy, currently known simply as PF-07321332, should effectively tackle all of them with strong efficacy.
Pfizer has a healthy balance sheet, a strong drug pipeline, a top-tier sales force, and a simply great R&D team. Let others follow meme stocks that are infinitesimally overvalued (i.e., really worth nothing), we will stick with beautiful workhorses like Pfizer. When the next correction comes, washing the silliness away, this 172-year-old stalwart will still be standing.
Global Trade
05. Parity must be the US goal with respect to trade with China
The press keeps telling us that China is about to reach economic parity with the United States, so here's our question to the collective press: why are we importing over four times as much from China as we export to China? If the economies are of equal scale, shouldn't our trade deficit with the communist nation be relatively balanced? In reality, the United States has a $22 trillion economy compared to China's $15 trillion or so, meaning we could even accept a 50% differential in the transfer of goods; but 400%? Something doesn't smell right.
In March, the most recent month on record, we exported $11.27 billion worth of goods to China and imported $48.21 billion worth of goods from China. While those figures are both depressing and outrageous, there is some good news: the US tariffs on Chinese goods are finally forcing US companies to look elsewhere for their purchases. One of the biggest beneficiaries in this shift has been Vietnam, which is now the eighth-largest exporter to the US, moving ahead of India. Vietnam, as we have noted in the past, is no friend to China, with the ongoing South China Sea dispute just the latest bone of contention between the two. The peak in our level of imports from China was $539 billion in 2018; as of the trailing twelve months (TTM) ended 31 March, that figure has dropped to $472 billion. A 12% drop doesn't sound like much, and the pandemic certainly skewed the results to some extent, but at least the needle is moving in the right direction.
Fortunately, the Biden administration has shown little inclination toward removing the tariffs on Chinese goods, much to the consternation of the CPC. Americans must keep up the pressure on companies to persuade them to look elsewhere for the wholesale purchase of products and building of new plants. If that pressure continues, China's five-year plan to overtake the US economically will face a much larger hurdle—despite the cheerleading from much of the press.
Technology is going to be, far and away, our greatest ally in the fight to curb Chinese imports. From 3D printing to vastly increased efficiency for manufacturing firms, technology is the great disruptor with respect to the balance of trade. Investors should keep a close eye on opportunities in the small- and mid-cap industrials space, those tech-heavy firms which almost always travel under the radar. We will continue to highlight individual names for readers.
Global Strategy: Europe
04. America is roaring out of the pandemic; that is not so much the case in Europe
Over the course of the last two quarters, covering the end of 2020 and the beginning of 2021, the US economy grew at an impressive clip of 4.3% and 6.4%, respectively, thanks to a herculean vaccination effort and a subsequent loosening of Covid restrictions. Sadly, this has not been the case across the pond. The latest metric comes from France, which just re-entered a recession. The French economy shrank by 0.1% in the first quarter of 2021, following a 1.5% contraction in Q4 of 2020. But Europe's second-largest economy has some good company: Germany, the eurozone's largest economy, has seen its economy shrink for five straight quarters, with Q1 GDP coming in at -3.10%. To be sure, the pandemic and a chaotic subsequent vaccine rollout have been the catalysts for the recession that Europe can't seem to shake, but there were other factors which prepared the field for these conditions.
While US deficit spending has been a sad, running joke for a number of years, Europe's fiscal policy almost makes America's economic house look enviable. After the Great Recession, Brussels, led by the erudite wonks primarily from France and Germany, spent with reckless abandon to help the poorer nations in the southern region shake off record levels of unemployment—like 28% in Greece and 26% in Spain. Austerity measures were then forced upon these borrowers which only served to exacerbate the problem and create resentment among the citizens of these beleaguered southern nations. Going into the pandemic, unemployment levels remained stubbornly high in Portugal, Italy, Greece, and Spain. In essence, the eurozone never shook off the effects of the 2008-2009 crisis when the global pandemic hit. The ECB's only answer seems to be throwing more money at the problem until it goes away. Eventually, Europe's vaccination rate will subdue the nightmarish pandemic and growth will return to the region. But the economic scars caused by the handling of two massive crises will remain, as will the bitter divide between the northern and southern regions of the continent.
We continue to underweight the eurozone—with the exception of a few emerging markets in Eastern Europe—as the region grapples with its reopening efforts. The UK is the wild card, as the 2017 Brexit outcome appears more and more prescient with each passing month. Goldman Sachs recently issued a glowing outlook for the British economy, anticipating a "striking" 7.8% GDP growth rate for the year. One way to play the anticipated rebound is with the iShares MSCI United Kingdom ETF (EWU $34), which holds 88 large-cap positions; names such as Unilever PLC and London Stock Exchange Group PLC. For investors looking for more growth potential there is the iShares MSCI United Kingdom Small-Cap ETF (EWUS $50), which holds several hundred small- and mid-cap names.
Road & Rail
03. The latest developments in the Kansas City Southern saga
When Canadian National Railway (CNI $113) stunned the industry with its $30 billion bid for Kansas City Southern (KSU $298), we fully expected rival Canadian Pacific Railway (CP $81) to up its prior $25 billion bid. Instead, the rail—which arguably needs the American north-south tracks of KSC more than Canadian National—stuck by its original offer. It also sent a message to Kansas City Southern: take our deal or lose the regulatory battle in the US. The Kansas City-based rail responded by telling Canadian Pacific to take a hike—and eat the $700 million deal breakup fee. At the heart of the issue are overlapping routes (Canadian National Railway has more) and stricter merger standards adopted in 2001 by the Surface Transportation Board (STB). The agency, which must approve or deny the merger, now states that railway mergers must be in the public interest; the older standard simply stated that a deal must not hinder competition. Canadian Pacific's plans? Wait out the ruling, which it expects to be negative, then swoop back in with its original deal.
This is a really tough call, as we see a 50/50 chance for ultimate approval by the STB. In the meantime, KSC seems too expensive (its price has risen to within 9% of the acquisition offer price), we don't like Canadian Pacific's tactics (and it seems fairly valued), and Canadian National will probably take a share price hit if the deal is shot down. That being said, we do like Canadian National's reach, which extends throughout Canada and all the way south to the Mexican border. It agreed to sell some of its southern-most lines to acquire KSC, but that would be a moot point if the deal fails. Of the major rails, CNI at $112.57 seems like the best bet right now for investors.
Biotechnology
02. In the war against Alzheimer's, a momentous day is coming
After a 12-month span in which most well-known health care stocks notched some impressive gains, one well-respected drug manufacturer seems to have been left behind. Biogen (BIIB $267), which has a solid bench of proven performers—like Tysabri for MS and Rituxan for cancer—and a decent pipeline of new therapies, is down 12.90% over the course of the past year. Something big is about to happen, however, that will (probably) move the shares sharply one way or the other, and send a critically-important signal on where we stand in the fight against Alzheimer's. Next Monday, the 7th of June, the US Food and Drug Administration will decide whether or not to approve the use of Biogen's Alzheimer's therapy, aducanumab. It is not just Biogen which will be watching the decision closely, it is also the families of the over six million sufferers of this terrible disease. Considering it has been nearly twenty years since an Alzheimer's therapy has been approved, a positive ruling would be an enormous win against what has been a very elusive disease.
There have been some oddly positive indicators that this drug will finally win approval, such as the very unique step of the FDA preparing a briefing document alongside Biogen on aducanumab. The stakes are high: generics have been slowly eating away at the company's anchor drugs, while approval of this Alzheimer's therapy would add immensely to the company's sales outlook for years to come. Our best guess? Investors should consider buying some shares at their current price of $267 in anticipation of a huge win.
Market Week in Review
01. In a stunning turnaround, two of the three major indexes actually cobbled together a positive May
It wasn't looking very good a few weeks into the new month. In fact, the "Sell in May..." adage seemed destined to, once again, prove true. However, after hammering out a solid second half of the month, both the S&P 500 and the Dow Jones Industrial Average ended May in the green—though not by much. While the NASDAQ couldn't make that happen, it did end up paring its earlier losses, finishing down just 1.53% on the month. Inflation fears seemed to grip the stock market in the first two weeks of May, while plenty of expert witnesses helped to effectively allay those fears during the second half of the month. For crypto investors, the story was more dour. Bitcoin lost one-third of its value in May. Bring on the dog days of summer, and strap in for a wild ride.
Under the Radar Investment
Kongsberg Gruppen ASA (NSKFF $25)
Kongsberg Gruppen ASA is a $4.5 billion Norwegian mid-cap industrials firm (try and find one of those in your portfolio). The company operates primarily in the Maritime and the Aerospace & Defense industries. The company's maritime unit makes navigation, automation, and positioning products for commercial ships and offshore industries. The aerospace unit provides an array of defense- and space-related products and services. Kongsberg has perennially-positive cash flow and a sound balance sheet. The company, which was founded in 1814, is based out of the Buskerud region of Norway.
Answer
According to the food industry publication Supermarket News, in 2018 US plant-based food sales sat at an impressive $4.5 billion. A year later, that figure grew to $5 billion—an 11% YoY growth rate compared to the 2.2% growth rate in total US retail food sales. In 2020, sales in the industry surged a whopping 27%, to $7 billion. Granted, overall retail food sales rose 15% (to $760 billion) due to closed restaurants and lockdowns, but to nearly double that rate says a lot about shifting dietary habits in the country. (And no, we are not knocking the summer delight that is a sizzling T-bone on the grill; it will be some time before that experience can be replicated.) 2021's figures, when they come out next April, will be a fascinating dot to add to the chart, as the lockdowns are essentially over in this country. What do we expect? Another surprisingly-high growth rate.*
*Granted, at 0.92% of overall food sales, the plant-based industry may seem like an afterthought from a sales standpoint. However, to us it simply portrays how much room the industry has to grow. Food products used to be a relatively boring corner of the consumer staples sector; thanks to visionaries like Beyond Meat's Ethan Brown, that is no longer the case...and we love it.
Headlines for the Week of 09 May—15 May 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
No putting that genie back in its bottle...
While Bank of America issued the first card using the concept of "revolving credit" back in 1958, what was the first credit card that could boast of widespread use?
Penn Trading Desk:
Penn: Add potential inflation hedge to the Dynamic Growth Strategy
It used to be so easy to hedge against inflation, just like it was easy to reduce beta in a portfolio by increasing the percentage of bonds in a portfolio. Ah, the good old days. We don't believe the current line that "inflation is transitory," and we are continually searching for creative hedges against this condition. To that end, we have added a position to the Penn Dynamic Growth Strategy, our ETF portfolio, which invests in companies that are expected to benefit from rising prices of real assets, i.e., inflation. Looking down the list of 40 or so holdings was like looking down one of our equity wish lists. A quite creative mix. Members can see the new addition by visiting the Penn Trading Desk and signing in.
Evercore ISI: Upgrade Simon Property Group to Outperform
We've talked relatively disparagingly about retail REIT Simon Property Group (SPG $120) in the past, but Evercore ISI has become a believer. The analyst firm upgraded their rating on SPG to Outperform, lifting their target price on the shares from $121 to $128. The analyst gave relatively generic rationale for the upgrade, to include a post-pandemic return to normalcy, improved rent collections, lower tenant fallout, and potential upside surprises to net operating income by the likes of JC Penney, Brooks Brothers, and other mall anchors.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Private equity firm Thoma Bravo makes bid for cybersecurity firm Proofpoint, sending shares soaring
Going into last week, Proofpoint (PFPT $173) was a $7.5 billion cloud-based cybersecurity firm with a suite of offerings for mid- to large-sized companies. After the following Monday's open, the company's offerings remained the same but its market cap was suddenly sitting near $11 billion thanks to an unsolicited bid by private equity firm Thoma Bravo. The deal, which would take the firm private, is worth $12.3 billion, or $176 per share, and comes with a 45-day "go-shop" provision which would allow other bids to be reviewed. Thoma Bravo, which specializes in software and cybersecurity acquisitions, just completed a $10 billion deal to buy RealPage, a provider of property management software for the commercial, single-family, and vacation rental housing industries. Barring any other offers, the Proofpoint deal should close in the third quarter.
Proofpoint is one of the top holdings in the First Trust NASDAQ Cybersecurity ETF (CIBR $45), a satellite holding within the Penn Dynamic Growth Strategy. While selecting individual cybersecurity names can be challenging for investors, we maintain that the best way to take part in this ever-growing industry is through a strong exchange traded fund, such as CIBR.
Automotive
09. Tesla's revenues surged 74% in the first quarter, leading to a record net income for the global EV leader
We remember listening to CNBC's David Faber ad nauseam: "Yes, Jim, but you do realize the company has never turned a profit, right?" We've never considered Mr. Brooks Brothers a lofty thinker, but his stale comments do make it all the more enjoyable to report that Tesla (TSLA $723) just notched its seventh-straight profitable quarter on the back of blowout numbers. For Q1 of 2021, Tesla generated $10.39 billion in revenue, with a record $438 million of that flowing down as net income. Addressing the new greatest threat to the automakers, the chip shortage, management said it has addressed the issue by moving to new microcontrollers for its vehicles and by developing the firmware required to work with the new chips made by different suppliers. Granted (we can hear Faber now), the company did make over $100 million by selling roughly 10% of its bitcoin stash at a profit, and another $500 million by the sale of tax credits, but the ever-increasing efficiency within their plants is undeniable. Tesla delivered a record 184,800 Model 3 and Model Y vehicles in Q1, and expects a 50% delivery growth rate this year over 2020. On the technical side of the business, Musk sees cameras replacing radar on its full self-driving (FSD) vehicles when they roll out, and expects to completely eliminate the old (radar-based) systems soon. In the earnings conference call, Musk also reiterated his aggressive plans to put more Tesla solar roofs on homes across America, supported by the company's home energy storage system known as Powerwall. The goal is to create a "giant distributed utility" which will ultimately make one's house energy self-sufficient.
There are always going to be naysaying journalists and analysts chronically pointing out why Tesla will ultimately fail. Their latest narrative is that increased competition within the EV and autonomous-driving space, along with the end of tax subsidies, will doom the company. Tesla is doing everything right to remain in the pole position going forward, however, and we consider its nationwide Supercharger network to be an enormous advantage over the competition. It should be noted that Tesla offered this technology to other automakers several years ago, but the offer was flatly declined.
Investment Vehicles: ETFs
08. Talk of raising the capital gains tax rate points to yet another reason we prefer ETFs over mutual funds
There are a number of reasons we migrated away from mutual funds in favor of exchange traded funds (ETFs) some years back, but the current tax rate discussion emanating from D.C. points to one specific benefit of the latter: their tax efficiency. As a young broker, one perennial pain came from the collection of mutual fund capital gains distribution figures for clients. Even if a client held a mutual fund throughout the entire year, they still had to pay taxes on the capital gains generated by the internal trades of the portfolio managers (PMs)—assuming the funds weren't held in an IRA, of course. For example, in the late 1990s the largest position held in client accounts was the venerable Growth Fund of America (AGTHX). The estimated capital gains distribution at year-end 2020 for AGTHX is 9-11%. Counter that with the 2020 capital gains distribution on the largest equity ETF, the SPDR S&P 500 ETF Trust (SPY): 0.00%. By law, open-end mutual funds must pass along capital gains to shareholders each year; there is no such requirement for ETFs. While the Biden administration is discussing a 39.6% capital gains tax rate on only the wealthiest of shareholders, does anyone really believe that the current rates for the rest of us will stay where they are now (0% to 20%, depending on the shareholder's tax bracket)? Yet another reason to favor ETFs in the taxable portion of your investment portfolio.
In the Penn Dynamic Growth Strategy, our ETF portfolio, we own a number of core funds designed to be held for the long haul, and satellite positions, designed to take advantage of current market and economic conditions. This is an excellent strategy for taxable accounts due to its relative tax efficiency. There are currently 23 funds (yes, one is an open-end fund we consider to be a stellar performer) in the Strategy.
Technology Hardware, Storage, & Peripherals
07. Apple vows to invest $430 billion and hire 20,000 new workers in the US over the next five years
Claiming that the company blew past its 2018 promise to invest $350 billion in the US, Apple's (AAPL $135) Tim Cook just announced bold new plans that would have the Cupertino-based firm adding another 20,000 US workers to the rolls (a 21% increase) and investing $430 billion in projects around the country. One of those projects will be a brand new campus and engineering hub in North Carolina which will create at least 3,000 AI, machine learning, software engineering, and other technical positions. Recall that the company just spent $1 billion on a new campus in Austin, Texas, which will be move-in ready next year. The new expenditures will focus on American suppliers, data center growth and enhancements, and Apple TV productions. Cook also added some very interesting comments following the investment announcements: he said that Apple was the largest taxpayer in the US, having paid over $45 billion in corporate income taxes over the past five years. That was a not-so-subtle message to D.C. that the big growth engines of the country—the large companies which each employ tens of thousands of American workers—are paying their fair share. We would like to add to the inference: the small- and medium-sized American companies which employ 65% of the US workforce are also paying their fair share.
Apple remains one of our strongest conviction stocks within the Penn Global Leaders Club. When a short seller or analyst comes along and attempts to besmirch the bright future of this company, investors should be prepared to pounce on any negative reaction within the share price.
Metals & Mining
06. Outcome of Peruvian national election highlights the country risk associated with precious metals and mining stocks
Trying to root out socialism from Latin America is a monumental challenge at best, an exercise in futility at worst. For evidence of this, just look to Venezuela. Despite the nightmarish economic situation for Venezuelans (like five hours in line for a few rolls of toilet paper), Hugo Chavez wannabe Nicolas Maduro remains in power, despite having the personality of a single-ply square of...Venezuelan toilet paper. Heading further down the South American continent we have the Republic of Peru: a relative bastion of free trade in the region—at least up until this point. The rather shocking results of the national elections held earlier this month set up socialist candidate Pedro Castillo to coast into the presidency following a June runoff (he holds a 20-point lead over his opponent, the market-friendly Keiko Fujimori). Which leads us to mining companies in general, and Southern Copper (SCCO $72) specifically.
Thanks to the global rebound, the outlook for metals—especially those with heavy industrial usage such as copper—is bright. Peru is the world's second-largest source of copper, and a majority of Southern Copper's mining operations reside within that country. While Castillo is trying to temper the harshness of his message leading into the runoff, his talk of nationalizing private companies operating inside the country has spooked investors. His party's platform, in fact, talks of "taking control" of the nation's natural resources. For $57 billion Souther Copper, which recently announced $8 billion in new Peruvian projects, there should be cause for concern. In fact, considering the remainder of their operations are in Mexico, which has been methodically moving left, there should be cause for extreme concern.
We remain very bullish on both precious metals/minerals as well as those used for industrial purposes. In fact, if the new Peruvian government were to nationalize the miners (not beyond the realms of possibility), copper prices would shoot even higher than they already are. Great for commodity investors; not so much for those who took a chance on individual miners like Southern Copper. While we do own two gold miners in the Penn Global Leaders Club, it is a safer bet to own sector or thematic ETFs to take advantage of anticipated growth. A few worth looking at are the US Global GO Gold and Precious Metal Miners ETF (GOAU $20), and the SPDR Gold Shares ETF (GLD $165). We own the latter in the Penn Dynamic Growth Strategy as a satellite position, and the current price of gold $1,777) makes it an attractive opportunity right now—in our opinion.
There are some excellent mining stocks in which to invest, and they are often in the small- to mid-cap sweet spot. However, investors need to perform their due diligence and understand exactly where the respective company's mines are located, and what the geopolitical risks are within that country or region.
Household & Personal Products
05. Jessica Alba's Honest Company is open for trading, but can it compete with the likes of Procter & Gamble and Kimberly-Clark?
Hollywood star Jessica Alba was plagued by asthma and allergies as a child to the point of being hospitalized on several occasions due to her maladies. Those experiences helped shape her thoughts on personal health, ultimately leading to her decision to launch The Honest Company (HNST $15) a decade ago. The Honest Company is a consumer products firm which offers a growing line of eco-friendly baby supplies (primarily diapers), bath and skincare products, and home cleaning solutions. There are over 2,500 chemicals and materials the company excludes from its products due to their potentially harmful effects on either the body or the environment.
How has Alba's concept resonated with consumers? Overall, pretty well. The company's products are now available at 32,000 various retailers throughout the US and Canada, including big players like Target (TGT) and Walgreens Boots Alliance (WBA). While still operating in the red, the company's revenues rose from $235M in 2019 to $300M in 2020 (+28%) and losses were stanched from -$31M to -$14M (a 55% improvement) over the same time frame. Leading into Wednesday's IPO, HNST shares were priced in the $14 to $17 range. They shot out of the gate at $23 per share and have fallen precipitously ever since. The company's valuation now sits at $1.4 billion, but is it worth even that much?
There is a mountain of competition in this space—both the personal care products industry in general and the eco-friendly corner specifically. Having Jessica Alba's sway certainly helps, but facing down the market caps of Procter ($330B), Unilever PLC ($155B), Kimberly-Clark ($46B), and an army of "green" players will be a herculean task. Furthermore, the aforementioned stocks all come with nice dividend yields, while HNST will need to plow its capital back into its strategic growth efforts.
Nonetheless, we do see a faithful and growing customer base. Honest estimates it currently holds about 5% market share in its space, and 55% of revenues are generated online. We believe it could easily double its market share in the short term, generating in excess of $500 million in revenues by 2023; maybe even becoming profitable by that point. The company is worth keeping an eye on, and the products are also worth a look.
HNST shares have now lost about one-third of their value since IPO day. If they drop to the $10/share range, we believe they will be undervalued and worth looking at for a potential purchase.
Global Strategy: East & Southeast Asia
04. Why do we care what Covid vaccine Philippine President Rodrigo Duterte chose to receive?
Roughly 20,000 American soldiers died defending the Philippines during World War II; about half were lost in battle while the other half succumbed to disease. The United States has enjoyed—actually, earned—an incredibly good relationship with the Southeast Asian country ever since General Douglas MacArthur uttered the infamous words in 1942: "I came through...and I shall return." To say that the Philippines sits in an important region of the world is an understatement. About one-fifth of global trade passes through the South China Sea, and trillions of dollars’ worth of oil and gas resources reside beneath its waves. The US military regularly patrols the region, with the Theodore Roosevelt and Nimitz Carrier Strike Groups conducting joint exercises in the waters this past February.
China has continued to make outrageous claims on enormous swaths of the South China Sea—as shown by the red dashed line on the accompanying map—much to the consternation of its neighbors in the region. Now, the communist nation seems to be strongly wooing the mercurial and dictatorial leader of the Philippines, Rodrigo Duterte. The latest sign of the love affair came with Duterte’s decision to receive the underwhelming Chinese Covid vaccine known as Sinovac. Recent results from Brazil show a 50% effectiveness rate for the Chinese product. The Philippines’ Covid rate is the second highest in Southeast Asia, behind only Indonesia.
While the choice of a vaccine is certainly anecdotal (though he did also praise Russia’s near-comical vaccine, Sputnik V), there is little doubt that Duterte is an iron-fisted leader who is on the outs with the United States right now, and that China would love to count on him as an ally in the region. The South China Sea seems to be quickly replacing the Persian Gulf as the most troublesome hot spot in the world.
Outside of the Philippines, all other nations in the region have serious disagreements with China. That nation’s ham-handed approach to diplomacy will not serve them well over the coming years, but more countries need to follow Australia’s lead and refuse to be bullied by the ruling Communist Party of China. America, through its military presence in the region, must make it clear that a massive land grab by fiat is unacceptable.
Demographics & Lifestyle
03. A most excellent problem: credit card issuers concerned as Americans continue to pay down their debt
We've often wondered what the overall economic health of the typical American household would look like if revolving debt did not exist. After all, it wasn't until Bank of America (BAC $42) issued the first credit card with a "revolving credit" feature in 1958 that Americans began racking up debt not backed by any tangible property, such as a home or an auto. Before then, money borrowed on a card had to be paid off at the end of each month. And despite the near-zero Fed funds rate, many cardholders are still being charged confiscatory interest rates of 16.99% to 19.99% on their balances, or even higher.
Now for the good news. Much to the chagrin of the card-issuing banks, which toughen their standards when people need the money the most and loosen them when they don't, borrowers are paying down their debt at impressive levels. During the company's most recent earnings call, card issuer Discover Financial Services (DFS $115) said that balances paid off recently have hit levels not seen since 2000. All of the top card issuers, in fact, have reported significant declines in the aggregate balance of revolving debt owed. While Americans put nearly $4 trillion on their cards in 2020, the total US credit card debt outstanding now sits at $819 billion--a significant decrease from pre-pandemic levels. It's hard to say whether this will turn into a healthy, long-term trend, but more and more people are becoming cognizant of just how much they owe, and what they have been paying for the "privilege" of buying on credit.
Once Americans get their own fiscal house in order, perhaps they will look at the $28.3 trillion of outstanding debt their government has racked up and demand accountability. The current rationale for spending trillions more than what is brought in via taxation is the pandemic. But what's the excuse for the reckless and wanton spending before the crippling disaster hit?
Cybersecurity
02. Despite the company's original denials, Colonial Pipeline reportedly paid hackers $5 million in ransom
A few months ago, we reported about a hack on a municipal water treatment plant in Florida. The hacker was attempting to adjust the chlorine level in the city’s water supply to toxic levels. That attack was thwarted by an attentive city worker who noticed a mouse cursor mysteriously moving on his computer screen. This past week brought us news of a successful hack on the Colonial Pipeline, the largest pipeline for refined oil products in the US. The 5,500-mile-long system, which carries 3 million barrels of fuel per day between Texas and New York, was shut down for days, causing massive gas lines along the East Coast.
While the company initially denied paying ransom to the hackers, it now appears that $5 million was, indeed, paid to a group known as DarkSide shortly after the attack occurred. DarkSide is a highly sophisticated criminal organization based out of Eastern Europe, with definite Russian connections. The cybercriminals use ransomware to lock a victim’s system, promising to provide the digital “keys” to unlock the system once the monetary demands are met. Experts are surprised that the amount demanded in this case was so low; normally, with a company of this size and services with such a broad scope, a $30 million demand would not be out of the ordinary.
Ransomware attacks on firms of all sizes more than tripled in 2020, with victims ponying up over $350 million in crypto ransoms. As is typical following such an attack, the US government said it would be setting up a task force to counter these threats. Sadly, these promises always seem to come along after the damage is done. This is yet another sobering reminder of just how vulnerable American companies and individuals are to cybercriminals, and how disruptive a simple digital act of aggression can become, literally overnight. While it is up to the government to go after the bad actors and nation-states involved in these crimes, it is up to each American to take all possible measures to assure their own system’s security profile is as robust as possible.
On the personal defense front, we have found Bitdefender to be one of the best cybersecurity suites on the market, for both PCs and MacBooks. Kaspersky ranks highly on most lists, but it is headquartered in Russia, which makes us immediately suspicious. From an investment standpoint, we believe the First Trust NASDAQ Cybersecurity ETF (CIBR $43) is an effective way to invest in the growing need for digital protection. We own CIBR as a satellite position within the Penn Dynamic Growth Strategy.
Market Week in Review
01. Inflation fears brought an ugly first half to the week for the markets, followed by an impressive comeback effort
The extent to which investors have been indifferent about inflation concerns is rather remarkable, considering the grand economic reopening which is in its nascent stage and the mounting evidence that the concern is real—as evidenced by the price of everything from used cars to commodities. Perhaps they were taking solace in Jerome Powell's nonchalant attitude, with the Fed Chair almost daring inflation to try and stir trouble. That changed this past Wednesday when, following two previous down days, the major indexes threw a major fit over the latest Consumer Price Index (CPI) report. The CPI, which measures the rate of change in the price of a basket of consumer goods, spiked 4.2% YoY, above the lofty expectations for a 3.6% reading. That jump represents the sharpest spike since September of 2008. By Wednesday's close, the major indexes were off between 2% and 2.67%, with the NASDAQ getting hit the hardest. Fears that the Fed would have to act sooner rather than later to rein in inflation seemed to abate after the mid-week bloodbath, with the Dow gaining nearly 1,000 points during the last two sessions, and the S&P gaining 110 points. Stocks typically face a higher level of volatility in May, as investors seem intent on proving the "Sell in May..." adage. What is the right course of action after such a volatile week? Take a good look at your portfolio's allocation to assure the fast-growing tech positions didn't knock it out of whack; also, position more toward the value side of the equation. On that note, take a look at our latest addition to the Dynamic Growth Strategy by visiting the Penn Trading Desk.
Under the Radar Investment
Masimo Corp (MASI $220)
Masimo is a US-based medical device company which focuses on noninvasive patient monitoring. For individuals, the firm offers state-of-the-art pulse oximeters for measuring oxygen saturation levels and pulse rates, wearable "smart" thermometers which allow parents to keep a constant eye on a sick child's temperature level, and sleep improvement devices. For medical facilities, Masimo offers a comprehensive patient monitoring and connectivity platform. Sadly, due to the global pandemic millions of people are now familiar with the company's products. Demand and name recognition helped drive MASI shares up to $285 this past January, but they have since pulled back into a nice buying range. While we don't currently own the company within the Penn strategies, we believe a fair value for the shares is around $300.
Answer
The Diners Club Card was created in 1950 after businessman Frank McNamara forgot his wallet while attending a business dinner in New York. By 1951, there were 20,000 Diners Club members. For its part, American Express introduced the first plastic credit card in 1959, with over one million in use by the mid 1960s.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
No putting that genie back in its bottle...
While Bank of America issued the first card using the concept of "revolving credit" back in 1958, what was the first credit card that could boast of widespread use?
Penn Trading Desk:
Penn: Add potential inflation hedge to the Dynamic Growth Strategy
It used to be so easy to hedge against inflation, just like it was easy to reduce beta in a portfolio by increasing the percentage of bonds in a portfolio. Ah, the good old days. We don't believe the current line that "inflation is transitory," and we are continually searching for creative hedges against this condition. To that end, we have added a position to the Penn Dynamic Growth Strategy, our ETF portfolio, which invests in companies that are expected to benefit from rising prices of real assets, i.e., inflation. Looking down the list of 40 or so holdings was like looking down one of our equity wish lists. A quite creative mix. Members can see the new addition by visiting the Penn Trading Desk and signing in.
Evercore ISI: Upgrade Simon Property Group to Outperform
We've talked relatively disparagingly about retail REIT Simon Property Group (SPG $120) in the past, but Evercore ISI has become a believer. The analyst firm upgraded their rating on SPG to Outperform, lifting their target price on the shares from $121 to $128. The analyst gave relatively generic rationale for the upgrade, to include a post-pandemic return to normalcy, improved rent collections, lower tenant fallout, and potential upside surprises to net operating income by the likes of JC Penney, Brooks Brothers, and other mall anchors.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Private equity firm Thoma Bravo makes bid for cybersecurity firm Proofpoint, sending shares soaring
Going into last week, Proofpoint (PFPT $173) was a $7.5 billion cloud-based cybersecurity firm with a suite of offerings for mid- to large-sized companies. After the following Monday's open, the company's offerings remained the same but its market cap was suddenly sitting near $11 billion thanks to an unsolicited bid by private equity firm Thoma Bravo. The deal, which would take the firm private, is worth $12.3 billion, or $176 per share, and comes with a 45-day "go-shop" provision which would allow other bids to be reviewed. Thoma Bravo, which specializes in software and cybersecurity acquisitions, just completed a $10 billion deal to buy RealPage, a provider of property management software for the commercial, single-family, and vacation rental housing industries. Barring any other offers, the Proofpoint deal should close in the third quarter.
Proofpoint is one of the top holdings in the First Trust NASDAQ Cybersecurity ETF (CIBR $45), a satellite holding within the Penn Dynamic Growth Strategy. While selecting individual cybersecurity names can be challenging for investors, we maintain that the best way to take part in this ever-growing industry is through a strong exchange traded fund, such as CIBR.
Automotive
09. Tesla's revenues surged 74% in the first quarter, leading to a record net income for the global EV leader
We remember listening to CNBC's David Faber ad nauseam: "Yes, Jim, but you do realize the company has never turned a profit, right?" We've never considered Mr. Brooks Brothers a lofty thinker, but his stale comments do make it all the more enjoyable to report that Tesla (TSLA $723) just notched its seventh-straight profitable quarter on the back of blowout numbers. For Q1 of 2021, Tesla generated $10.39 billion in revenue, with a record $438 million of that flowing down as net income. Addressing the new greatest threat to the automakers, the chip shortage, management said it has addressed the issue by moving to new microcontrollers for its vehicles and by developing the firmware required to work with the new chips made by different suppliers. Granted (we can hear Faber now), the company did make over $100 million by selling roughly 10% of its bitcoin stash at a profit, and another $500 million by the sale of tax credits, but the ever-increasing efficiency within their plants is undeniable. Tesla delivered a record 184,800 Model 3 and Model Y vehicles in Q1, and expects a 50% delivery growth rate this year over 2020. On the technical side of the business, Musk sees cameras replacing radar on its full self-driving (FSD) vehicles when they roll out, and expects to completely eliminate the old (radar-based) systems soon. In the earnings conference call, Musk also reiterated his aggressive plans to put more Tesla solar roofs on homes across America, supported by the company's home energy storage system known as Powerwall. The goal is to create a "giant distributed utility" which will ultimately make one's house energy self-sufficient.
There are always going to be naysaying journalists and analysts chronically pointing out why Tesla will ultimately fail. Their latest narrative is that increased competition within the EV and autonomous-driving space, along with the end of tax subsidies, will doom the company. Tesla is doing everything right to remain in the pole position going forward, however, and we consider its nationwide Supercharger network to be an enormous advantage over the competition. It should be noted that Tesla offered this technology to other automakers several years ago, but the offer was flatly declined.
Investment Vehicles: ETFs
08. Talk of raising the capital gains tax rate points to yet another reason we prefer ETFs over mutual funds
There are a number of reasons we migrated away from mutual funds in favor of exchange traded funds (ETFs) some years back, but the current tax rate discussion emanating from D.C. points to one specific benefit of the latter: their tax efficiency. As a young broker, one perennial pain came from the collection of mutual fund capital gains distribution figures for clients. Even if a client held a mutual fund throughout the entire year, they still had to pay taxes on the capital gains generated by the internal trades of the portfolio managers (PMs)—assuming the funds weren't held in an IRA, of course. For example, in the late 1990s the largest position held in client accounts was the venerable Growth Fund of America (AGTHX). The estimated capital gains distribution at year-end 2020 for AGTHX is 9-11%. Counter that with the 2020 capital gains distribution on the largest equity ETF, the SPDR S&P 500 ETF Trust (SPY): 0.00%. By law, open-end mutual funds must pass along capital gains to shareholders each year; there is no such requirement for ETFs. While the Biden administration is discussing a 39.6% capital gains tax rate on only the wealthiest of shareholders, does anyone really believe that the current rates for the rest of us will stay where they are now (0% to 20%, depending on the shareholder's tax bracket)? Yet another reason to favor ETFs in the taxable portion of your investment portfolio.
In the Penn Dynamic Growth Strategy, our ETF portfolio, we own a number of core funds designed to be held for the long haul, and satellite positions, designed to take advantage of current market and economic conditions. This is an excellent strategy for taxable accounts due to its relative tax efficiency. There are currently 23 funds (yes, one is an open-end fund we consider to be a stellar performer) in the Strategy.
Technology Hardware, Storage, & Peripherals
07. Apple vows to invest $430 billion and hire 20,000 new workers in the US over the next five years
Claiming that the company blew past its 2018 promise to invest $350 billion in the US, Apple's (AAPL $135) Tim Cook just announced bold new plans that would have the Cupertino-based firm adding another 20,000 US workers to the rolls (a 21% increase) and investing $430 billion in projects around the country. One of those projects will be a brand new campus and engineering hub in North Carolina which will create at least 3,000 AI, machine learning, software engineering, and other technical positions. Recall that the company just spent $1 billion on a new campus in Austin, Texas, which will be move-in ready next year. The new expenditures will focus on American suppliers, data center growth and enhancements, and Apple TV productions. Cook also added some very interesting comments following the investment announcements: he said that Apple was the largest taxpayer in the US, having paid over $45 billion in corporate income taxes over the past five years. That was a not-so-subtle message to D.C. that the big growth engines of the country—the large companies which each employ tens of thousands of American workers—are paying their fair share. We would like to add to the inference: the small- and medium-sized American companies which employ 65% of the US workforce are also paying their fair share.
Apple remains one of our strongest conviction stocks within the Penn Global Leaders Club. When a short seller or analyst comes along and attempts to besmirch the bright future of this company, investors should be prepared to pounce on any negative reaction within the share price.
Metals & Mining
06. Outcome of Peruvian national election highlights the country risk associated with precious metals and mining stocks
Trying to root out socialism from Latin America is a monumental challenge at best, an exercise in futility at worst. For evidence of this, just look to Venezuela. Despite the nightmarish economic situation for Venezuelans (like five hours in line for a few rolls of toilet paper), Hugo Chavez wannabe Nicolas Maduro remains in power, despite having the personality of a single-ply square of...Venezuelan toilet paper. Heading further down the South American continent we have the Republic of Peru: a relative bastion of free trade in the region—at least up until this point. The rather shocking results of the national elections held earlier this month set up socialist candidate Pedro Castillo to coast into the presidency following a June runoff (he holds a 20-point lead over his opponent, the market-friendly Keiko Fujimori). Which leads us to mining companies in general, and Southern Copper (SCCO $72) specifically.
Thanks to the global rebound, the outlook for metals—especially those with heavy industrial usage such as copper—is bright. Peru is the world's second-largest source of copper, and a majority of Southern Copper's mining operations reside within that country. While Castillo is trying to temper the harshness of his message leading into the runoff, his talk of nationalizing private companies operating inside the country has spooked investors. His party's platform, in fact, talks of "taking control" of the nation's natural resources. For $57 billion Souther Copper, which recently announced $8 billion in new Peruvian projects, there should be cause for concern. In fact, considering the remainder of their operations are in Mexico, which has been methodically moving left, there should be cause for extreme concern.
We remain very bullish on both precious metals/minerals as well as those used for industrial purposes. In fact, if the new Peruvian government were to nationalize the miners (not beyond the realms of possibility), copper prices would shoot even higher than they already are. Great for commodity investors; not so much for those who took a chance on individual miners like Southern Copper. While we do own two gold miners in the Penn Global Leaders Club, it is a safer bet to own sector or thematic ETFs to take advantage of anticipated growth. A few worth looking at are the US Global GO Gold and Precious Metal Miners ETF (GOAU $20), and the SPDR Gold Shares ETF (GLD $165). We own the latter in the Penn Dynamic Growth Strategy as a satellite position, and the current price of gold $1,777) makes it an attractive opportunity right now—in our opinion.
There are some excellent mining stocks in which to invest, and they are often in the small- to mid-cap sweet spot. However, investors need to perform their due diligence and understand exactly where the respective company's mines are located, and what the geopolitical risks are within that country or region.
Household & Personal Products
05. Jessica Alba's Honest Company is open for trading, but can it compete with the likes of Procter & Gamble and Kimberly-Clark?
Hollywood star Jessica Alba was plagued by asthma and allergies as a child to the point of being hospitalized on several occasions due to her maladies. Those experiences helped shape her thoughts on personal health, ultimately leading to her decision to launch The Honest Company (HNST $15) a decade ago. The Honest Company is a consumer products firm which offers a growing line of eco-friendly baby supplies (primarily diapers), bath and skincare products, and home cleaning solutions. There are over 2,500 chemicals and materials the company excludes from its products due to their potentially harmful effects on either the body or the environment.
How has Alba's concept resonated with consumers? Overall, pretty well. The company's products are now available at 32,000 various retailers throughout the US and Canada, including big players like Target (TGT) and Walgreens Boots Alliance (WBA). While still operating in the red, the company's revenues rose from $235M in 2019 to $300M in 2020 (+28%) and losses were stanched from -$31M to -$14M (a 55% improvement) over the same time frame. Leading into Wednesday's IPO, HNST shares were priced in the $14 to $17 range. They shot out of the gate at $23 per share and have fallen precipitously ever since. The company's valuation now sits at $1.4 billion, but is it worth even that much?
There is a mountain of competition in this space—both the personal care products industry in general and the eco-friendly corner specifically. Having Jessica Alba's sway certainly helps, but facing down the market caps of Procter ($330B), Unilever PLC ($155B), Kimberly-Clark ($46B), and an army of "green" players will be a herculean task. Furthermore, the aforementioned stocks all come with nice dividend yields, while HNST will need to plow its capital back into its strategic growth efforts.
Nonetheless, we do see a faithful and growing customer base. Honest estimates it currently holds about 5% market share in its space, and 55% of revenues are generated online. We believe it could easily double its market share in the short term, generating in excess of $500 million in revenues by 2023; maybe even becoming profitable by that point. The company is worth keeping an eye on, and the products are also worth a look.
HNST shares have now lost about one-third of their value since IPO day. If they drop to the $10/share range, we believe they will be undervalued and worth looking at for a potential purchase.
Global Strategy: East & Southeast Asia
04. Why do we care what Covid vaccine Philippine President Rodrigo Duterte chose to receive?
Roughly 20,000 American soldiers died defending the Philippines during World War II; about half were lost in battle while the other half succumbed to disease. The United States has enjoyed—actually, earned—an incredibly good relationship with the Southeast Asian country ever since General Douglas MacArthur uttered the infamous words in 1942: "I came through...and I shall return." To say that the Philippines sits in an important region of the world is an understatement. About one-fifth of global trade passes through the South China Sea, and trillions of dollars’ worth of oil and gas resources reside beneath its waves. The US military regularly patrols the region, with the Theodore Roosevelt and Nimitz Carrier Strike Groups conducting joint exercises in the waters this past February.
China has continued to make outrageous claims on enormous swaths of the South China Sea—as shown by the red dashed line on the accompanying map—much to the consternation of its neighbors in the region. Now, the communist nation seems to be strongly wooing the mercurial and dictatorial leader of the Philippines, Rodrigo Duterte. The latest sign of the love affair came with Duterte’s decision to receive the underwhelming Chinese Covid vaccine known as Sinovac. Recent results from Brazil show a 50% effectiveness rate for the Chinese product. The Philippines’ Covid rate is the second highest in Southeast Asia, behind only Indonesia.
While the choice of a vaccine is certainly anecdotal (though he did also praise Russia’s near-comical vaccine, Sputnik V), there is little doubt that Duterte is an iron-fisted leader who is on the outs with the United States right now, and that China would love to count on him as an ally in the region. The South China Sea seems to be quickly replacing the Persian Gulf as the most troublesome hot spot in the world.
Outside of the Philippines, all other nations in the region have serious disagreements with China. That nation’s ham-handed approach to diplomacy will not serve them well over the coming years, but more countries need to follow Australia’s lead and refuse to be bullied by the ruling Communist Party of China. America, through its military presence in the region, must make it clear that a massive land grab by fiat is unacceptable.
Demographics & Lifestyle
03. A most excellent problem: credit card issuers concerned as Americans continue to pay down their debt
We've often wondered what the overall economic health of the typical American household would look like if revolving debt did not exist. After all, it wasn't until Bank of America (BAC $42) issued the first credit card with a "revolving credit" feature in 1958 that Americans began racking up debt not backed by any tangible property, such as a home or an auto. Before then, money borrowed on a card had to be paid off at the end of each month. And despite the near-zero Fed funds rate, many cardholders are still being charged confiscatory interest rates of 16.99% to 19.99% on their balances, or even higher.
Now for the good news. Much to the chagrin of the card-issuing banks, which toughen their standards when people need the money the most and loosen them when they don't, borrowers are paying down their debt at impressive levels. During the company's most recent earnings call, card issuer Discover Financial Services (DFS $115) said that balances paid off recently have hit levels not seen since 2000. All of the top card issuers, in fact, have reported significant declines in the aggregate balance of revolving debt owed. While Americans put nearly $4 trillion on their cards in 2020, the total US credit card debt outstanding now sits at $819 billion--a significant decrease from pre-pandemic levels. It's hard to say whether this will turn into a healthy, long-term trend, but more and more people are becoming cognizant of just how much they owe, and what they have been paying for the "privilege" of buying on credit.
Once Americans get their own fiscal house in order, perhaps they will look at the $28.3 trillion of outstanding debt their government has racked up and demand accountability. The current rationale for spending trillions more than what is brought in via taxation is the pandemic. But what's the excuse for the reckless and wanton spending before the crippling disaster hit?
Cybersecurity
02. Despite the company's original denials, Colonial Pipeline reportedly paid hackers $5 million in ransom
A few months ago, we reported about a hack on a municipal water treatment plant in Florida. The hacker was attempting to adjust the chlorine level in the city’s water supply to toxic levels. That attack was thwarted by an attentive city worker who noticed a mouse cursor mysteriously moving on his computer screen. This past week brought us news of a successful hack on the Colonial Pipeline, the largest pipeline for refined oil products in the US. The 5,500-mile-long system, which carries 3 million barrels of fuel per day between Texas and New York, was shut down for days, causing massive gas lines along the East Coast.
While the company initially denied paying ransom to the hackers, it now appears that $5 million was, indeed, paid to a group known as DarkSide shortly after the attack occurred. DarkSide is a highly sophisticated criminal organization based out of Eastern Europe, with definite Russian connections. The cybercriminals use ransomware to lock a victim’s system, promising to provide the digital “keys” to unlock the system once the monetary demands are met. Experts are surprised that the amount demanded in this case was so low; normally, with a company of this size and services with such a broad scope, a $30 million demand would not be out of the ordinary.
Ransomware attacks on firms of all sizes more than tripled in 2020, with victims ponying up over $350 million in crypto ransoms. As is typical following such an attack, the US government said it would be setting up a task force to counter these threats. Sadly, these promises always seem to come along after the damage is done. This is yet another sobering reminder of just how vulnerable American companies and individuals are to cybercriminals, and how disruptive a simple digital act of aggression can become, literally overnight. While it is up to the government to go after the bad actors and nation-states involved in these crimes, it is up to each American to take all possible measures to assure their own system’s security profile is as robust as possible.
On the personal defense front, we have found Bitdefender to be one of the best cybersecurity suites on the market, for both PCs and MacBooks. Kaspersky ranks highly on most lists, but it is headquartered in Russia, which makes us immediately suspicious. From an investment standpoint, we believe the First Trust NASDAQ Cybersecurity ETF (CIBR $43) is an effective way to invest in the growing need for digital protection. We own CIBR as a satellite position within the Penn Dynamic Growth Strategy.
Market Week in Review
01. Inflation fears brought an ugly first half to the week for the markets, followed by an impressive comeback effort
The extent to which investors have been indifferent about inflation concerns is rather remarkable, considering the grand economic reopening which is in its nascent stage and the mounting evidence that the concern is real—as evidenced by the price of everything from used cars to commodities. Perhaps they were taking solace in Jerome Powell's nonchalant attitude, with the Fed Chair almost daring inflation to try and stir trouble. That changed this past Wednesday when, following two previous down days, the major indexes threw a major fit over the latest Consumer Price Index (CPI) report. The CPI, which measures the rate of change in the price of a basket of consumer goods, spiked 4.2% YoY, above the lofty expectations for a 3.6% reading. That jump represents the sharpest spike since September of 2008. By Wednesday's close, the major indexes were off between 2% and 2.67%, with the NASDAQ getting hit the hardest. Fears that the Fed would have to act sooner rather than later to rein in inflation seemed to abate after the mid-week bloodbath, with the Dow gaining nearly 1,000 points during the last two sessions, and the S&P gaining 110 points. Stocks typically face a higher level of volatility in May, as investors seem intent on proving the "Sell in May..." adage. What is the right course of action after such a volatile week? Take a good look at your portfolio's allocation to assure the fast-growing tech positions didn't knock it out of whack; also, position more toward the value side of the equation. On that note, take a look at our latest addition to the Dynamic Growth Strategy by visiting the Penn Trading Desk.
Under the Radar Investment
Masimo Corp (MASI $220)
Masimo is a US-based medical device company which focuses on noninvasive patient monitoring. For individuals, the firm offers state-of-the-art pulse oximeters for measuring oxygen saturation levels and pulse rates, wearable "smart" thermometers which allow parents to keep a constant eye on a sick child's temperature level, and sleep improvement devices. For medical facilities, Masimo offers a comprehensive patient monitoring and connectivity platform. Sadly, due to the global pandemic millions of people are now familiar with the company's products. Demand and name recognition helped drive MASI shares up to $285 this past January, but they have since pulled back into a nice buying range. While we don't currently own the company within the Penn strategies, we believe a fair value for the shares is around $300.
Answer
The Diners Club Card was created in 1950 after businessman Frank McNamara forgot his wallet while attending a business dinner in New York. By 1951, there were 20,000 Diners Club members. For its part, American Express introduced the first plastic credit card in 1959, with over one million in use by the mid 1960s.
Headlines for the Week of 18 Apr—24 Apr 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
American leadership in human spaceflight is back. Thank you Elon...
America willingly—and disgustingly—gave up its ability to launch astronauts into orbit back in 2011. After a decade of no manned launches from American soil, how many astronauts have been launched into space since last June aboard SpaceX rockets?
Penn Trading Desk:
Bank of America/Citi: Upgrade First Solar
One of our favorite renewable energy companies, First Solar (FSLR $84), popped over 5% following an upgrade at both Bank of America and Citi. The BofA analyst cited a green infrastructure plan coming from Washington and accelerated near-term bookings momentum as catalysts for the upgrade. Citi, which upgraded FSLR shares from Hold to Buy, cited tailwinds from US tax and trade policies. We place the fair value of FSLR shares at $100.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. As expected, Coinbase shot out of the gate in its debut trading day; then something interesting happened
Despite an initial pricing range of around $250 per share, cryptocurrency exchange Coinbase (COIN $288) opened on the Nasdaq at $381 then quickly rocketed to nearly $430 per share. That mark put a sky-high valuation on the firm at $112 billion, but woe to the investors who wantonly bought in within the first few minutes of trading. Unlike many other recent IPOs with similar levels of rabid interest, shares of COIN began faltering almost immediately, falling all the way back to $311 within two hours of the company's first trade. Shares closed the day at $335.90, or 22% off of their high. While the closing price gave the exchange a more reasonable market cap, we believe it is still overvalued. We do like the fact that Coinbase is a play not on one particular cyrpto, but on a number of reasonably solid players. In fact, it acts as something of a gatekeeper, keeping more questionable digital currencies from being traded on the platform. Bitcoin and Ethereum trading generated nearly 60% of the firm's revenue in 2020. One clear winner on the day was the Nasdaq exchange, with Coinbase representing its first direct listing. At its size, in fact, COIN became the largest company to ever take the direct listing route. There was a heated competition between the NYSE and the Nasdaq to land the deal, but Coinbase's CFO said the fact that the latter had the symbol "COIN" played a part in the company's decision to go with that exchange. Here's what worries us most about Coinbase: there are few barriers to entry for would-be competitors. In fact, the fat fees the exchange charges almost begs the competition to come flooding in with the promise of lower costs to the customer. Nonetheless, the company has grand strategic plans of building out a complete suite of financial services over the coming years. They will, more than likely, succeed with those plans.
So, we are relatively bullish on Coinbase, but believe COIN shares are overvalued and that the industry has few barriers to entry. With all of that in the mix, what's an intriguing price point for a buying opportunity? We would say anywhere around $250 per share, which is where we set our own price alert.
Space Sciences & Exploration
09. NASA awards SpaceX contract to build the spacecraft which will take astronauts back to the moon
It was initially whittled down to three companies—Musk's SpaceX, Bezos' Blue Origin, and Dynetics—but we had our hunch as to who would walk away with the prize; the prize being a coveted NASA contract to develop the craft which will take astronauts back to the moon. Blue Origin tried to stack the deck in their favor by teaming up with the likes of Lockheed Martin (LMT) and Northrop Grumman (NOC) and by calling their group a "national team." In the end, however, SpaceX was awarded the $2.9 billion contract. And why not? While other companies have fiddled or floundered, SpaceX has been busy sending astronauts and cargo to the International Space Station (ISS). Real feats, funded with real revenue. Most importantly, in the extreme-risk arena of human spaceflight, SpaceX has won the trust of America's space agency. The United States launched the Artemis program back in 2017 with the express goal of landing men and women on the moon by 2024, fifty-two years after Gene Cernan and Harrison Schmitt crawled back into their lunar module and gently lifted off from the moon's surface as part of their Apollo 17 mission. Who could have imagined back in 1972 that it would take us so long to return. While the 2024 target might have to be pushed out, by nominating former astronaut and US Senator Bill Nelson to head up the space agency, President Biden has signaled his support for a strong US manned space program; quite a different story from his Democratic predecessor, Barrack Obama.
SpaceX's Crew Dragon Endeavour spacecraft is slated to launch on its next mission to the ISS this coming Thursday. On board will be mission commander Shane Kimbrough, pilot Megan McArthur, Japanese astronaut Akihiko Hoshide, and European Space Agency mission specialist Thomas Pesquet.
Internet Retail
08. Amazon set to test furniture and appliance assembly service
Amazon (AMZN $3,411) appears poised to encroach on more turf, and this time the likes of Home Depot, Lowe's, and Wayfair could be affected. The $1.7 trillion Internet retailer will begin testing a product assembly service in several markets this summer, with drivers delivering, unpacking, and assembling everything from beds to treadmills, taking away all of the packing material when done. Customers will even have the option of sending the items back on the spot if dissatisfied with a product once assembled. While the furniture assembly service would most affect the likes of a Wayfair (W $324), moving into the setup of appliances such as washing machines, dishwashers, and ceiling fans would impact the likes of Home Depot (HD $328) and Lowe's (LOW $206). Taking it a step further, ordering big-screen televisions through Amazon and having the price include mounting and setup would affect electronics retailers such as Best Buy (BBY $120). Behind the scenes, however, Amazon is already facing pushback from drivers and delivery workers who fear getting bogged down by the inevitable in-home challenges. Concerns include having customers hover over them during the assembly process, and the company not taking into account any delays caused by unique in-home circumstances such as space constraints.
Our first inclination was to disregard any employee grumblings—Amazon tends to get its way in such matters. However, there are so many unique challenges bound to arise for a non-specialty company such as Amazon trying to train its delivery specialists on the assembly of a multitude of products that the success of this program is far from given. We will keep an eye out for the anecdotal—yet highly entertaining—stories which are sure to make their rounds on social media.
Industrials: Road & Rail
07. A new twist—and a new Canadian player—in the Kansas City Southern saga
Last month we reported on the probable loss of one of America's storied railroads—Kansas City Southern (KSU $298)—as it agreed to be acquired by larger rival to the north, Canadian Pacific (CP $357). The plan called for the $47 billion Canadian rail to buy the north/south American rail for $25 billion plus the assumption of another $4 billion in debt (equivalent to roughly $275/sh). We also noted that last fall KSU rejected a bid by the Blackstone Group (BX $80) to pay shareholders $208/sh to take the firm private. We thought the CP deal was a fait accompli until this week's shocker from an even larger Canadian rail.
Canadian National Railway (CNI $110), which has a market cap of nearly $80 billion, has made a $30 billion bid for KSU, valuing the deal at $325/share and promising to keep KSU's headquarters in Kansas City. While the terms are more favorable for KSU shareholders, there is another factor which will almost certainly come into play: due to a bit more overlap, Canadian National will face a higher regulatory hurdle, with no guarantee of ultimate approval on either side of the border. Despite its smaller size, Kansas City Southern is a coveted jewel of the industry, operating as the only rail going into both Canada to the north and Mexico to the south. As USMCA picks up steam, the importance of one company's ability to transport raw materials from Canada, American farm goods to Mexico, and autos and industrial products back from Mexico cannot be overstated. It even operates a rail link along one side of the Panama Canal. Executives at KSU said they are reviewing the deal and would respond to CP in due course, but shareholders are already cheering the offer: KSU shares were trading up 16% after terms of the deal were announced.
While we would like to see KSU remain independent, odds are very high that one of these deals will ultimately be approved. And, quite frankly, the powerhouse which would be created from a merger is exciting to ponder. Our gut instinct, based on over two decades of following the rail stocks, tells us that the Canadian National Railway merger would offer the best comprehensive outcome—except for Canadian Pacific, of course.
Furnishings, Fixtures, & Appliances
06. Herman Miller and Knoll to merge, creating office furnishings powerhouse
We first highlighted office furnishings company Knoll (KNL $24) in our June, 2015 issue of The Penn Wealth Report. At the time, we were fully engrossed in the final season of the hit AMC television series Mad Men. Knoll, which epitomized the modernist design movement stemming from Munich in the early 20th century, could have easily been responsible for every office scene from the fictional Sterling Cooper ad agency. Quite understandably, the company took a huge hit as offices around the world began shutting their doors last March, with KNL shares falling from nearly $30 going into the year to $9.05 by that terrible week in late March. The same was true for one of Knoll's prime competitors, 116-year-old interior furnishings company Herman Miller (MLHR $41), whose shares fell from near $50 to $15.15 in March of 2020. While both of these small-cap cyclicals rode out the storm and have witnessed a strong comeback in their respective share price, they have made the very intelligent decision to join forces. In a cash-and-stock deal valued at $1.8 billion, the two companies plan to morph into a global leader of modern design not only for the corporate office world, but also to serve the needs of the growing throng of workers who will operate either full- or part-time within their homes. In a joint statement issued by the firms, a strategic plan for "transforming the home and office sectors at a time of unprecedented disruption" was outlined. As Herman Miller was the larger of the two companies, each Knoll shareholder will receive $11 in cash and 0.32 shares of Herman Miller for each share owned, while current MLHR shareholders will end up owning around 78% of the combined entity. The two companies have, in aggregate, a presence in over 100 countries, and both have developed strong e-commerce platforms. Heading into the pandemic, the two had combined annual revenues of $4 billion.
We love the deal, and we expect to see these two American companies pull off a relatively smooth integration. It is not easy to be an American manufacturing firm making high-quality products in a world of cheaper imports, but we fully believe the combined entity will skillfully carry out its bold new strategy. The deal should close by the end of the third quarter.
Government Watchdog
05. So you desire to have a home in New Jersey? Be prepared to pay confiscatory property taxes
We have long espoused the view that property taxes assessed on single-family homes should be capped at 1% per year. After all, in addition to every other tax Americans must pay, isn't $5,000 per year on a $500,000 home enough income for a homeowner's state and local government, on top of the other tax revenues generated? But in many states, the effective property tax rate is much higher than our proposed cap. Take New Jersey, for example, which happens to have the highest property tax rate in the nation. While the state's marginal rate is a sky-high 2.2%, the effective real estate tax rate is 2.47%. That equates to a $5,064 tax bill on a very modest $205,000 home. The effective taxes on a home priced at $327,900, the state's median home value, is $8,104. Perhaps what shocked us the most as we looked at each state's 2020 property tax figures was California's number: the Golden State actually capped the rate at 1% of assessed value, with a 2% annual cap on value increases. Of course, Californians must also contend with a 9.3% income tax rate (on income between $58.6k and $299.5k—it goes up from there) and a 7.25% tax on goods purchased. The opposite end of the spectrum from New Jersey, at least with respect to property taxes, is Hawaii with its 0.28% rate. That would equate to just a $1,715 tax bill on a home valued at $615,300, the median home value in the state.
While moving isn't always an option—for any number of reasons—all Americans should be aware of their individual state's property tax rate, income tax rate, and sales tax rate (the last will fluctuate within various parts of the state). Combined, these three figures represent one's overall tax burden for living where they do. Of interest: Alaska has the lowest overall tax burden of any state in the union, at roughly 5.8% (the state has no sales tax); while Illinois comes in with the most burdensome rate in the country, at 15%.
Global Strategy: Europe
04. The weaker candidate won the primary battle in Germany; may now lose the war to the Greens
Last week we outlined the internal struggles going on behind the scenes among the two leading center-right political parties in Germany, Merkel's Christian Democratic Union and Markus Söder's Christian Social Union of Bavaria. The wildly popular Söder agreed to step aside if the CDU voted to support Merkel's candidate, the unpopular Armin Laschet. Despite the latter's weakness in the polls, that is exactly what her party did, and Söder, true to his word, stepped aside. While we said that the bloc's main competition would come from the center-left Social Democratic Party of Germany (SPD), a new frontrunner has emerged: the far-left Green party's Annalena Baerbock. The 40-year-old former champion trampolinist is promising Germans a "new start" for the country, with a focus on green energy and increased spending on eduction. A poll of German business leaders (a poll we highly question, it should be noted) favors Baerbock over Laschet by a comfortable margin. Clouding the outlook—and probably fracturing the vote in the general elections—are the two candidates from the SPD and the pro-business Free Democrats Party (FDP), Olaf Scholz and Christian Lindner, respectively. The general elections are precisely five months away.
With the best candidate for Germany's future (in our opinion) officially out of the race, the outcome is a flip of the coin. Our instincts tell us that Armin Laschet will come out on top, which will lead to a ho-hum period for the German economy. In a tantalizing twist of fate, that would probably tip the economic scales in Europe in favor of the breakaway "troublemaker," Great Britain. While it is brutally painful going through a domestic election, we have a deep sense of schadenfreude watching the "wise and sapient" Europeans squirm through theirs.
Semiconductors & Related Equipment
03. For true believers, Intel shares seem to be sitting at a decent buy-in point; we remain cautious
While we have talked glowingly about Intel's (INTC $59) new wonkish CEO, Pat Gelsinger, we still haven't pulled the trigger on re-adding the semiconductor maker to any of our portfolios. Management is saying the right things, and we applaud the company's decision to expand their own US manufacturing footprint, but we want to see some results first. A new data point did just roll in; unfortunately, it was not on the bullish side of the scatter plot. Shares of the $242 billion firm were off over 5% on Friday after announcing a strong drop in data center revenue—its most profitable segment—and a decline in gross profit margin. Sales from the Data Center Group fell 20% in the first quarter, year-over-year, well below what analysts were expecting. One anecdotal yet disturbing sign for the group came last month from tech giant Amazon (AMZN $3,370): the company announced that it would begin designing its own data center chips in-house.
Intel has made a string of very smart acquisitions over the past several years to take market share in the AI and EV segments, but it is going to take precision execution on management's part for the company to become a vibrant player in those nascent areas. If played correctly, the severe supply chain disruptions which led to the global chip shortage could provide Intel a nice tailwind. We will remain on the sideline while a few more chapters are written.
Market Pulse
02. Some rather volatile moves, but a flat week in the end; except for the cryptos
There were some wild gyrations in the markets this week, to include a tantrum over the specter of a doubling (for some) of the capital gains tax rate, but when the dust settled we ended up pretty close to where we began. All of the major indexes finished the five session period down, but not by much. Gold finished the week precisely where it started—$1,777 per ounce—and crude futures were off just a buck, to $62.04. The big story of the week was in cryptocurrencies. After prices began tumbling over the weekend, JP Morgan issued a rather dire warning that Bitcoin was due for some further weakness. After topping out at nearly $65,000 on the 14th of April, the digital currency had a steep decline over the weekend. When massively-leveraged bets are made on an investment vehicle, it doesn't take much of a catalyst to begin a massive selloff. As of Friday's close, Bitcoin was trading just shy of $52,000—a 20% drop from its high. The highly-touted Coinbase exchange (COIN $292) didn't fare much better; it was down 14% on the week. For those not willing to do the basic work (some Robinhood customers are claiming they didn't understand the concept of margin, though they had been using it in their accounts), it may be a long year indeed.
Cryptos are here to stay, but that doesn't mean a lack of extreme pullbacks in their respective prices on a regular basis. Some of them, in fact, won't survive. A wanton, meme-driven "strategy" for investing is a dangerous game to play. And that is not even taking margin into account.
Under the Radar Investment
01. Asseco Poland SA (ASOZY $18)
You know the international slice of your portfolio is sorely lacking, as is—more than likely—your small-cap allocation. Take a look at this financially sound, small-cap systems software company from one of our favorite countries in Europe. Asseco Poland SA is a $1.5 billion developer of sector-specific software for banking and finance, and manager of large IT projects in the fields of healthcare, telecom, and security services. With 27,000 employees, the company has a major presence in Europe and Israel, and generates the majority of its (nicely recurring) revenue from proprietary software licenses. With a tiny beta of 0.4181, a very reasonable P/E ratio of 14, and positive net income for the past decade, the company could be a nice play on the economic comeback in Europe. It also comes with a fat, 4.18% dividend yield. We believe that Poland, a staunchly-democratic, anti-communist country, has enormous economic potential over the coming years. It was recently upgraded from an emerging market to a developed market within the FTSE Country Classification framework. Asseco Poland was founded in 1989 and is headquartered in the southeastern Polish city of Rzeszów.
Answer
After the first manned test flight of the Dragon capsule last June with two astronauts onboard, two operational crew launches have taken place—each with a four-person crew. So, ten astronauts have now made the trip from American soil to the International Space Station within the past year.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
American leadership in human spaceflight is back. Thank you Elon...
America willingly—and disgustingly—gave up its ability to launch astronauts into orbit back in 2011. After a decade of no manned launches from American soil, how many astronauts have been launched into space since last June aboard SpaceX rockets?
Penn Trading Desk:
Bank of America/Citi: Upgrade First Solar
One of our favorite renewable energy companies, First Solar (FSLR $84), popped over 5% following an upgrade at both Bank of America and Citi. The BofA analyst cited a green infrastructure plan coming from Washington and accelerated near-term bookings momentum as catalysts for the upgrade. Citi, which upgraded FSLR shares from Hold to Buy, cited tailwinds from US tax and trade policies. We place the fair value of FSLR shares at $100.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. As expected, Coinbase shot out of the gate in its debut trading day; then something interesting happened
Despite an initial pricing range of around $250 per share, cryptocurrency exchange Coinbase (COIN $288) opened on the Nasdaq at $381 then quickly rocketed to nearly $430 per share. That mark put a sky-high valuation on the firm at $112 billion, but woe to the investors who wantonly bought in within the first few minutes of trading. Unlike many other recent IPOs with similar levels of rabid interest, shares of COIN began faltering almost immediately, falling all the way back to $311 within two hours of the company's first trade. Shares closed the day at $335.90, or 22% off of their high. While the closing price gave the exchange a more reasonable market cap, we believe it is still overvalued. We do like the fact that Coinbase is a play not on one particular cyrpto, but on a number of reasonably solid players. In fact, it acts as something of a gatekeeper, keeping more questionable digital currencies from being traded on the platform. Bitcoin and Ethereum trading generated nearly 60% of the firm's revenue in 2020. One clear winner on the day was the Nasdaq exchange, with Coinbase representing its first direct listing. At its size, in fact, COIN became the largest company to ever take the direct listing route. There was a heated competition between the NYSE and the Nasdaq to land the deal, but Coinbase's CFO said the fact that the latter had the symbol "COIN" played a part in the company's decision to go with that exchange. Here's what worries us most about Coinbase: there are few barriers to entry for would-be competitors. In fact, the fat fees the exchange charges almost begs the competition to come flooding in with the promise of lower costs to the customer. Nonetheless, the company has grand strategic plans of building out a complete suite of financial services over the coming years. They will, more than likely, succeed with those plans.
So, we are relatively bullish on Coinbase, but believe COIN shares are overvalued and that the industry has few barriers to entry. With all of that in the mix, what's an intriguing price point for a buying opportunity? We would say anywhere around $250 per share, which is where we set our own price alert.
Space Sciences & Exploration
09. NASA awards SpaceX contract to build the spacecraft which will take astronauts back to the moon
It was initially whittled down to three companies—Musk's SpaceX, Bezos' Blue Origin, and Dynetics—but we had our hunch as to who would walk away with the prize; the prize being a coveted NASA contract to develop the craft which will take astronauts back to the moon. Blue Origin tried to stack the deck in their favor by teaming up with the likes of Lockheed Martin (LMT) and Northrop Grumman (NOC) and by calling their group a "national team." In the end, however, SpaceX was awarded the $2.9 billion contract. And why not? While other companies have fiddled or floundered, SpaceX has been busy sending astronauts and cargo to the International Space Station (ISS). Real feats, funded with real revenue. Most importantly, in the extreme-risk arena of human spaceflight, SpaceX has won the trust of America's space agency. The United States launched the Artemis program back in 2017 with the express goal of landing men and women on the moon by 2024, fifty-two years after Gene Cernan and Harrison Schmitt crawled back into their lunar module and gently lifted off from the moon's surface as part of their Apollo 17 mission. Who could have imagined back in 1972 that it would take us so long to return. While the 2024 target might have to be pushed out, by nominating former astronaut and US Senator Bill Nelson to head up the space agency, President Biden has signaled his support for a strong US manned space program; quite a different story from his Democratic predecessor, Barrack Obama.
SpaceX's Crew Dragon Endeavour spacecraft is slated to launch on its next mission to the ISS this coming Thursday. On board will be mission commander Shane Kimbrough, pilot Megan McArthur, Japanese astronaut Akihiko Hoshide, and European Space Agency mission specialist Thomas Pesquet.
Internet Retail
08. Amazon set to test furniture and appliance assembly service
Amazon (AMZN $3,411) appears poised to encroach on more turf, and this time the likes of Home Depot, Lowe's, and Wayfair could be affected. The $1.7 trillion Internet retailer will begin testing a product assembly service in several markets this summer, with drivers delivering, unpacking, and assembling everything from beds to treadmills, taking away all of the packing material when done. Customers will even have the option of sending the items back on the spot if dissatisfied with a product once assembled. While the furniture assembly service would most affect the likes of a Wayfair (W $324), moving into the setup of appliances such as washing machines, dishwashers, and ceiling fans would impact the likes of Home Depot (HD $328) and Lowe's (LOW $206). Taking it a step further, ordering big-screen televisions through Amazon and having the price include mounting and setup would affect electronics retailers such as Best Buy (BBY $120). Behind the scenes, however, Amazon is already facing pushback from drivers and delivery workers who fear getting bogged down by the inevitable in-home challenges. Concerns include having customers hover over them during the assembly process, and the company not taking into account any delays caused by unique in-home circumstances such as space constraints.
Our first inclination was to disregard any employee grumblings—Amazon tends to get its way in such matters. However, there are so many unique challenges bound to arise for a non-specialty company such as Amazon trying to train its delivery specialists on the assembly of a multitude of products that the success of this program is far from given. We will keep an eye out for the anecdotal—yet highly entertaining—stories which are sure to make their rounds on social media.
Industrials: Road & Rail
07. A new twist—and a new Canadian player—in the Kansas City Southern saga
Last month we reported on the probable loss of one of America's storied railroads—Kansas City Southern (KSU $298)—as it agreed to be acquired by larger rival to the north, Canadian Pacific (CP $357). The plan called for the $47 billion Canadian rail to buy the north/south American rail for $25 billion plus the assumption of another $4 billion in debt (equivalent to roughly $275/sh). We also noted that last fall KSU rejected a bid by the Blackstone Group (BX $80) to pay shareholders $208/sh to take the firm private. We thought the CP deal was a fait accompli until this week's shocker from an even larger Canadian rail.
Canadian National Railway (CNI $110), which has a market cap of nearly $80 billion, has made a $30 billion bid for KSU, valuing the deal at $325/share and promising to keep KSU's headquarters in Kansas City. While the terms are more favorable for KSU shareholders, there is another factor which will almost certainly come into play: due to a bit more overlap, Canadian National will face a higher regulatory hurdle, with no guarantee of ultimate approval on either side of the border. Despite its smaller size, Kansas City Southern is a coveted jewel of the industry, operating as the only rail going into both Canada to the north and Mexico to the south. As USMCA picks up steam, the importance of one company's ability to transport raw materials from Canada, American farm goods to Mexico, and autos and industrial products back from Mexico cannot be overstated. It even operates a rail link along one side of the Panama Canal. Executives at KSU said they are reviewing the deal and would respond to CP in due course, but shareholders are already cheering the offer: KSU shares were trading up 16% after terms of the deal were announced.
While we would like to see KSU remain independent, odds are very high that one of these deals will ultimately be approved. And, quite frankly, the powerhouse which would be created from a merger is exciting to ponder. Our gut instinct, based on over two decades of following the rail stocks, tells us that the Canadian National Railway merger would offer the best comprehensive outcome—except for Canadian Pacific, of course.
Furnishings, Fixtures, & Appliances
06. Herman Miller and Knoll to merge, creating office furnishings powerhouse
We first highlighted office furnishings company Knoll (KNL $24) in our June, 2015 issue of The Penn Wealth Report. At the time, we were fully engrossed in the final season of the hit AMC television series Mad Men. Knoll, which epitomized the modernist design movement stemming from Munich in the early 20th century, could have easily been responsible for every office scene from the fictional Sterling Cooper ad agency. Quite understandably, the company took a huge hit as offices around the world began shutting their doors last March, with KNL shares falling from nearly $30 going into the year to $9.05 by that terrible week in late March. The same was true for one of Knoll's prime competitors, 116-year-old interior furnishings company Herman Miller (MLHR $41), whose shares fell from near $50 to $15.15 in March of 2020. While both of these small-cap cyclicals rode out the storm and have witnessed a strong comeback in their respective share price, they have made the very intelligent decision to join forces. In a cash-and-stock deal valued at $1.8 billion, the two companies plan to morph into a global leader of modern design not only for the corporate office world, but also to serve the needs of the growing throng of workers who will operate either full- or part-time within their homes. In a joint statement issued by the firms, a strategic plan for "transforming the home and office sectors at a time of unprecedented disruption" was outlined. As Herman Miller was the larger of the two companies, each Knoll shareholder will receive $11 in cash and 0.32 shares of Herman Miller for each share owned, while current MLHR shareholders will end up owning around 78% of the combined entity. The two companies have, in aggregate, a presence in over 100 countries, and both have developed strong e-commerce platforms. Heading into the pandemic, the two had combined annual revenues of $4 billion.
We love the deal, and we expect to see these two American companies pull off a relatively smooth integration. It is not easy to be an American manufacturing firm making high-quality products in a world of cheaper imports, but we fully believe the combined entity will skillfully carry out its bold new strategy. The deal should close by the end of the third quarter.
Government Watchdog
05. So you desire to have a home in New Jersey? Be prepared to pay confiscatory property taxes
We have long espoused the view that property taxes assessed on single-family homes should be capped at 1% per year. After all, in addition to every other tax Americans must pay, isn't $5,000 per year on a $500,000 home enough income for a homeowner's state and local government, on top of the other tax revenues generated? But in many states, the effective property tax rate is much higher than our proposed cap. Take New Jersey, for example, which happens to have the highest property tax rate in the nation. While the state's marginal rate is a sky-high 2.2%, the effective real estate tax rate is 2.47%. That equates to a $5,064 tax bill on a very modest $205,000 home. The effective taxes on a home priced at $327,900, the state's median home value, is $8,104. Perhaps what shocked us the most as we looked at each state's 2020 property tax figures was California's number: the Golden State actually capped the rate at 1% of assessed value, with a 2% annual cap on value increases. Of course, Californians must also contend with a 9.3% income tax rate (on income between $58.6k and $299.5k—it goes up from there) and a 7.25% tax on goods purchased. The opposite end of the spectrum from New Jersey, at least with respect to property taxes, is Hawaii with its 0.28% rate. That would equate to just a $1,715 tax bill on a home valued at $615,300, the median home value in the state.
While moving isn't always an option—for any number of reasons—all Americans should be aware of their individual state's property tax rate, income tax rate, and sales tax rate (the last will fluctuate within various parts of the state). Combined, these three figures represent one's overall tax burden for living where they do. Of interest: Alaska has the lowest overall tax burden of any state in the union, at roughly 5.8% (the state has no sales tax); while Illinois comes in with the most burdensome rate in the country, at 15%.
Global Strategy: Europe
04. The weaker candidate won the primary battle in Germany; may now lose the war to the Greens
Last week we outlined the internal struggles going on behind the scenes among the two leading center-right political parties in Germany, Merkel's Christian Democratic Union and Markus Söder's Christian Social Union of Bavaria. The wildly popular Söder agreed to step aside if the CDU voted to support Merkel's candidate, the unpopular Armin Laschet. Despite the latter's weakness in the polls, that is exactly what her party did, and Söder, true to his word, stepped aside. While we said that the bloc's main competition would come from the center-left Social Democratic Party of Germany (SPD), a new frontrunner has emerged: the far-left Green party's Annalena Baerbock. The 40-year-old former champion trampolinist is promising Germans a "new start" for the country, with a focus on green energy and increased spending on eduction. A poll of German business leaders (a poll we highly question, it should be noted) favors Baerbock over Laschet by a comfortable margin. Clouding the outlook—and probably fracturing the vote in the general elections—are the two candidates from the SPD and the pro-business Free Democrats Party (FDP), Olaf Scholz and Christian Lindner, respectively. The general elections are precisely five months away.
With the best candidate for Germany's future (in our opinion) officially out of the race, the outcome is a flip of the coin. Our instincts tell us that Armin Laschet will come out on top, which will lead to a ho-hum period for the German economy. In a tantalizing twist of fate, that would probably tip the economic scales in Europe in favor of the breakaway "troublemaker," Great Britain. While it is brutally painful going through a domestic election, we have a deep sense of schadenfreude watching the "wise and sapient" Europeans squirm through theirs.
Semiconductors & Related Equipment
03. For true believers, Intel shares seem to be sitting at a decent buy-in point; we remain cautious
While we have talked glowingly about Intel's (INTC $59) new wonkish CEO, Pat Gelsinger, we still haven't pulled the trigger on re-adding the semiconductor maker to any of our portfolios. Management is saying the right things, and we applaud the company's decision to expand their own US manufacturing footprint, but we want to see some results first. A new data point did just roll in; unfortunately, it was not on the bullish side of the scatter plot. Shares of the $242 billion firm were off over 5% on Friday after announcing a strong drop in data center revenue—its most profitable segment—and a decline in gross profit margin. Sales from the Data Center Group fell 20% in the first quarter, year-over-year, well below what analysts were expecting. One anecdotal yet disturbing sign for the group came last month from tech giant Amazon (AMZN $3,370): the company announced that it would begin designing its own data center chips in-house.
Intel has made a string of very smart acquisitions over the past several years to take market share in the AI and EV segments, but it is going to take precision execution on management's part for the company to become a vibrant player in those nascent areas. If played correctly, the severe supply chain disruptions which led to the global chip shortage could provide Intel a nice tailwind. We will remain on the sideline while a few more chapters are written.
Market Pulse
02. Some rather volatile moves, but a flat week in the end; except for the cryptos
There were some wild gyrations in the markets this week, to include a tantrum over the specter of a doubling (for some) of the capital gains tax rate, but when the dust settled we ended up pretty close to where we began. All of the major indexes finished the five session period down, but not by much. Gold finished the week precisely where it started—$1,777 per ounce—and crude futures were off just a buck, to $62.04. The big story of the week was in cryptocurrencies. After prices began tumbling over the weekend, JP Morgan issued a rather dire warning that Bitcoin was due for some further weakness. After topping out at nearly $65,000 on the 14th of April, the digital currency had a steep decline over the weekend. When massively-leveraged bets are made on an investment vehicle, it doesn't take much of a catalyst to begin a massive selloff. As of Friday's close, Bitcoin was trading just shy of $52,000—a 20% drop from its high. The highly-touted Coinbase exchange (COIN $292) didn't fare much better; it was down 14% on the week. For those not willing to do the basic work (some Robinhood customers are claiming they didn't understand the concept of margin, though they had been using it in their accounts), it may be a long year indeed.
Cryptos are here to stay, but that doesn't mean a lack of extreme pullbacks in their respective prices on a regular basis. Some of them, in fact, won't survive. A wanton, meme-driven "strategy" for investing is a dangerous game to play. And that is not even taking margin into account.
Under the Radar Investment
01. Asseco Poland SA (ASOZY $18)
You know the international slice of your portfolio is sorely lacking, as is—more than likely—your small-cap allocation. Take a look at this financially sound, small-cap systems software company from one of our favorite countries in Europe. Asseco Poland SA is a $1.5 billion developer of sector-specific software for banking and finance, and manager of large IT projects in the fields of healthcare, telecom, and security services. With 27,000 employees, the company has a major presence in Europe and Israel, and generates the majority of its (nicely recurring) revenue from proprietary software licenses. With a tiny beta of 0.4181, a very reasonable P/E ratio of 14, and positive net income for the past decade, the company could be a nice play on the economic comeback in Europe. It also comes with a fat, 4.18% dividend yield. We believe that Poland, a staunchly-democratic, anti-communist country, has enormous economic potential over the coming years. It was recently upgraded from an emerging market to a developed market within the FTSE Country Classification framework. Asseco Poland was founded in 1989 and is headquartered in the southeastern Polish city of Rzeszów.
Answer
After the first manned test flight of the Dragon capsule last June with two astronauts onboard, two operational crew launches have taken place—each with a four-person crew. So, ten astronauts have now made the trip from American soil to the International Space Station within the past year.
Headlines for the Week of 11 Apr—17 Apr 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Hasbro's first hit toy...
Hasbro can trace its roots back to 1923, but its first major hit rolled along in 1952. What was that beloved toy?
Penn Trading Desk:
Penn: Add media conglomerate to the Intrepid
Just because we are not fans of a company doesn't mean we can't make money off of it. That is the scenario under which we picked up shares of a media giant whose price rose too quickly, then fell too sharply. The ideal place for a company we don't love—or even necessarily like? Anyone following the five Penn strategies knows there is only one good fit: the Penn Intrepid Trading Platform. Our target price is precisely 50% above where we purchased the shares. For details of the trade, sign into the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Global Strategy: Southeast Asia
10. In a refreshing move, Western companies are finally speaking out against China's horrendous human rights abuses
In the current zeitgeist, many large American companies seem to have no problem wading into domestic politics—a taboo policy until quite recently. Now, in a refreshing move, some surprising players are finally willing to shine a light on the human rights abuses committed by the Communist Party of China. The largest footwear and athletic apparel brand in the world, Nike (NKE $133), saw its shares take a hit last week after the company denounced the forced labor of Chinese Uyghers and other ethnic minorities throughout various parts of China. Swedish fashion conglomerate H&M (HMRZF $24) announced that it would stop buying cotton from the Xinjiang region of northwest China after confirmed reports of forced labor. Burberry, Adidas, and New Balance have issued similar statements condemning the conditions. In another refreshing move, the governments of the EU, the UK, the US, and Canada jointly issued a statement denouncing the treatment of minorities in China. Now, as could be expected, calls to boycott Nike and H&M have sprung up across China. As the communist party controls virtually every aspect of media—to include social media—within China, the boycotts could have been easily predicted. How badly could these companies be hurt by a boycott? Considering that 36% of Nike's production and 22% of the company's sales emanate from China, there will be some pain felt. However, this should serve as an excellent wake up call for organizations which have become overly reliant on one closed society's cheap labor and growing middle class. Perhaps they will now consider China's more open-society neighbors to the south and east as a location for new plants and for new sources of revenue.
It has been widely reported that China is turning more towards Russia and North Korea as it faces ever-increasing blowback for its unacceptable actions. That shouldn't come as a surprise, considering the similar nature of all three governments. The importance of US leadership in building an international alliance against human rights atrocities cannot be overstated. As the world's largest economy, America must counter China's Belt and Road Initiative (BRI), which will serve as a spreader for these practices, by building stronger economic and political alliances with countries around the world instead of acting unilaterally.
Capital Markets
09. We knew several major media and entertainment stocks fell sharply, now we begin to see the formerly-unknown fallout
In the matter of a week, former high-flying media darlings Discovery (DISCA $42) and ViacomCBS (VIAC $46) saw there share prices slashed roughly in half, without any clear-cut catalyst. Investors saw that bloodbath unfold in real time, but something else was going on behind the scenes which was neither clear nor transparent. One family office group (FOG), Archegos Capital, founded by former Tiger Management analyst Bill Hwang, had amassed major stakes in both of these firms and a number of Chinese Internet ADRs. As the shares began to crater, margin calls began rolling in from Archegos lenders, primarily Credit Suisse and Nomura, forcing the FOG to sell shares—thus exacerbating the initial drop. Both of these foreign lenders warned of big losses after announcing that "a significant US-based hedge fund had defaulted on margin calls," causing the shares of each to drop around 13%. It is too early to tell just how much Archegos and its lenders have lost in this nightmarish downward spiral, but it will certainly be in the billions of dollars for each of the players. Of interesting note: Goldman Sachs, Morgan Stanley, and Deutsche Bank rapidly unloaded big blocks of shares last week which were tied to Archegos. In other words, they got out before incurring the losses felt by Credit Suisse and Nomura. The incident is especially troubling for Credit Suisse, which already faced massive losses from the collapse of UK investment partner Greensill Capital, and a reported February loss of over $1 billion stemming from a US court case over questionable securities.
Here is what's most disturbing about this case: Neither Credit Suisse nor Nomura shareholders were wise to the banks' dealings with Archegos or the extent to which the hedge fund had leveraged its media holdings. This is due to an exclusion made for family office groups in Dodd-Frank legislation, exempting them from the the same level of SEC reporting with which non-FOGs must comply. Odds are extremely high that by the time the dust settles on this saga these rules will have been "amended."
Science & Technology Investor
08. Cathie Wood's ARK Space Exploration & Innovation ETF makes its debut
To say that Cathie Wood, founder, CEO, and CIO of ARK Investment Management, has made a big splash in the investment world is an understatement. Her skills at uncovering and investing in primarily small- and mid-cap tech and innovation companies (and increased marketing, of course) have led to a stunning inflow of funds during a horrendously tough year—her firm's assets under management (AUM) went from around $2.6 billion to over $50 billion. This week, Wood launched her latest gem: the ARK Space Exploration and Innovation ETF (ARKX $20). The fund, according to ARK, will invest in companies operating under one of four areas: orbital aerospace, suborbital aerospace, enabling technologies, and aerospace beneficiaries (e.g. Internet access). The top holding (of around 50) is scientific and technical instruments maker Trimble (TRMB $78); others in the top-ten list include Kratos Defense & Security (KTOS), L3 Harris Technologies (LHX), and Iridium Communications (IRDM). It would be safe to assume that SpaceX will be among the holdings when that company ultimately goes public. I must admit to being excited about this fund, and appreciate the company's complete transparency with respect to buys and sells—what a refreshing concept.
Based on the explosive growth in all things tech and space related as of late, is this fund overvalued out of the gate? I don't believe so. Looking through the holdings, many are industrial or tech names which are not on most investors' radar screens. It is an impressive lineup.
Economics: Work & Pay
07. A spectacular jobs report pushes equities higher
Yes, yes, we know it will take like ten more jobs reports similar to the one we got for March to get us back anywhere near where we were in February of 2020, but let's take some time and savor this one. While the markets were closed on Good Friday, futures shot up nonetheless on news that the US added 916,000 new jobs in the month of March against economists' expectations for 618,000. Even better, the hiring was broad-based, spread out among virtually every corner of the private sector. Notable strength was seen in leisure and hospitality (the group hit hardest during the heart of the pandemic), education, health care, and construction. The US unemployment rate dropped from 6.2% to 6%, while the more comprehensive U-6 rate (which includes all persons marginally attached to the labor force) dropped from 11.1% to 10.7%. Even better than simply a stunning report, the areas of weakness (such as wages) gave investors confidence that the Fed wouldn't accelerate plans to raise rates. Even after digesting the news for three days, investors were still applauding the report on Monday morning, as all major indexes rose in excess of 1% out of the gates.
Warmer weather, more vaccines, strong hiring—we can feel the momentum building. Out litmus test for the great economic comeback will be full NFL stadiums this fall; and yes, we expect that to be the case. Our dual goals, post-pandemic? More "shop local," and less "Made in China."
Market Pulse
06. Jamie Dimon sees economic boom continuing into 2023, but also sees challenges to address
In his annual letter to JP Morgan (JPM $153) shareholders, CEO Jamie Dimon said he sees strong growth for the American economy "easily running into 2023." Dimon, one of the most astute watchers of the market, listed a host of factors for his bullish sentiment on the world's largest economy: the remarkable speed at which a vaccine was developed, excess savings for the typical American family after being homebound for much of the past year, huge deficit spending, more quantitative easing by the Fed, a new infrastructure bill, and general euphoria that the long global nightmare may finally be coming to an end. His letter wasn't all rosy, however. Dimon sees a real possibility that inflation "will not be just temporary," and he expressed his concerns that our international rivals see a nation "torn and crippled by politics...." "The good news," Dimon concluded, "is that this is fixable."
There have always been fomenters of discord and division in this country. There is no doubt that our adversaries, such as China and Russia, are stealthily acting to support such hatred and division. America is, by far, the strongest nation on earth, both economically and militarily—that is a statistically provable fact, not hyperbole. The best weapon our enemies have to harm our standing in the world is to help balkanize the country into groups pitted against one another. Their efforts will fail if we refuse to play their game.
Application & Systems Software
05. Another smart move by Satya Nadella: Microsoft to buy AI firm Nuance in $19.7 billion deal
CEO Satya Nadella continues to aggressively transform Microsoft (MSFT $255), with his latest move being the acquisition of pioneering speech-recognition ("conversational AI") company Nuance (NUAN) for $19.7 billion ($16 billion plus assumption of debt). The all-cash deal values Nuance at $56 per share, or a 23% premium over Friday's close. The move should give Microsoft a greater presence in the growing field of health information services, and should also be cause for concern for the likes of $22 billion, Missouri-based Cerner (CERN $73). Nuance offers health care professionals the tools to recognize and transcribe speech during doctor's visits, both in-person and digital (telemedicine). Appointment management, patient support, and the efficient creation and maintenance of complete medical records are a few of Nuance's extensive list of offerings. While health care is the leading source the firm's revenues, it also operates in the financial services, telecom, retail, and government sectors. The deal would represent Microsoft's second-largest ever, behind only the 2016 acquisition of LinkedIn for $27 billion.
Microsoft is one of the forty holdings within the Penn Global Leaders Club, and remains one of our strongest-conviction buys at its current price.
Global Strategy: Europe
04. Could an internecine battle in Germany help bring about a major regime change?
For some reason, it seems as though it has been about five years since Angela Merkel announced that she would be stepping down from her role as Chancellor of Germany—a position (stepping down, that is) rather forced upon her by the party she led between 2000 and 2018, the Christian Democratic Union (CDU). In what seems to be dragging on longer than Brexit, the battle for her successor just took a dramatic turn.
While there are roughly a dozen political parties in the country, the ruling alliance between the center-right CDU and the center-right Christian Social Union in Bavaria (CSU) has been a stabilizing factor in the country since nearly the end of World War II. Generally, the leader of the larger CDU, Merkel's party, gets the nod to represent the alliance in the national election. And, indeed, Merkel has backed her party's leader, Armin Laschet, to succeed her. However, the more charismatic Markus Söder, head of the CSU, believes that he is the right person for the job, and his party just sent a shocking snub to Merkel's pick. Söder points out how far the CDU has fallen in the polls since the former journalist took the reins of the party from Merkel three years ago. He is correct on both counts: that the party has fallen from grace since 2018, and that he could energize the electorate more than Laschet.
Of course, this battle has the center-left Social Democratic Party of Germany (SPD) licking its chops. It sees its own nominee, Olaf Scholz, gaining from the disarray. To further complicate the matter, Scholz is not only Merkel's deputy vice chancellor, he actually lost the race to be the leader of his own party. We won't even get into the far-left Green Party, or the far-right Alternative for Germany (AfD), or even the Pirate Party, which opposes the EU's data retention policies. It should be fun to watch (from across the ocean) as battles play out over the next five months—the country has set its official federal election date as 26 September 2021.
The ugliness could spiral out of control, with a real possibility that Scholz could pull out a victory. Considering the gargantuan problems facing Germany right now, perhaps the real question should be why would anyone want to be chancellor?
Cryptocurrencies
03. There is an enormous crypto opportunity coming Wednesday via direct listing; should you buy?
If we ever had any doubts about the long-term viability of cryptos, that ended when it became clear that China has plans to create its own global reserve currency (dollar envy). It has decided to do that in the form of a government-backed digital currency, a sovereign Bitcoin if you will. Technically called the Digital Currency Electronic Payment, or DCEP, the currency will allow the Communist Party of China to further control the entire banking system in China and, in the hopes and dreams of the master planners, create a tool to overtake the dollar as the world's reserve currency. Will it work? Probably not—at least not to the extent China hopes. However, it points to the critical importance of the American government both understanding and embracing cryptos.
On that note, Something big will happen in the crypto world on Wednesday: Coinbase will go public via a direct listing. As the largest cryptocurrency exchange, the San Fran-based company (though it has no official physical headquarters) acts as a secure online platform for buying, selling, transferring, and storing digital currency. The fact that it is part of the support structure, rather than an entity tied to the success of any one single crypto such as Bitcoin, makes the company extremely interesting. Not only that, it is (get ready) already profitable! The firm had a blowout Q1, with earning of around $800 million on revenues of $7.2 billion. And that revenue base represented an 850% spike from the same quarter a year earlier. There is only one problem with this intriguing investment. With the rabid interest circulating around cryptos and the millions of new myopic retail investors now in the game, Coinbase will probably come out of the chute with a market cap in excess of $100 billion, and some will be willing to jump in at any price ("diamond hands, baby"). We will be watching the action closely, and if the price is too expensive on its first day of trading we recommend investors wait for the shares to come down and settle within a reasonable range.
Cryptos, despite what we said about their inevitable future, still operate in a normal market cycle of peaks, contractions, troughs, and expansions. Don't get too caught up in the hype: when everyone is jumping into the water with their eyes closed, it is always wise advice to wait until the sharks send them fleeing for safety.
Media & Entertainment
02. Physical games meet digital gaming as Roblox and Hasbro team up
Last month we wrote about the exciting new (to the markets) online entertainment platform Roblox (RBLX $83), which allows users to code their own games and share them for other gamers to play—often earning a little profit in the process. One 98-year-old gaming company which few associate with technology, Hasbro (HAS $99), is hoping to breathe some new life into its lineup by joining forces with the online platform. Specifically, the toy and game company's Nerf and Monopoly lines will soon include codes for Roblox players to redeem for virtual items. Additionally, a number of Roblox games will be created around the iconic products. For example, buy a Nerf Blaster and receive a code to score an online Nerf Blaster to use in games such as Jailbreak and Arsenal. A new version of Monopoly, to be available later this year, will include Roblox characters and come with codes to acquire other online items. We're not sure which company came up with the brainstorm, but if it was Hasbro's idea, it is the latest in a series of smart moves. Recall that five years ago the company scored a major coup in taking the Disney line away from Mattel (MAT $20) after a sixty year relationship was fractured. For an old-school toy company living in a digital world, Hasbro continues to impress.
The ten-year chart of Hasbro vs Mattel highlights the great struggle between the two iconic brands. Some analysts still believe that $14 billion Hasbro should acquire Mattel, half its size. There is little doubt that the former is leading the latter in digital acumen; plus, who wouldn't want to own the coveted Barbie and American Girl lines?
Under the Radar Investment
01. Accolade Inc
There are many corners of the health care market with which investors are enamored, from big pharma to biotech to medical devices and testing, but one area which remains relatively ignored is the health information services arena. The industry made news this week with Microsoft's announcement that it would buy Nuance in a nearly $20 billion deal, but a firm much deeper under the radar screen of investors is $2.8 billion Accolade Inc (ACCD $48). Accolade is a tech-based firm which helps employers provide individualized health care "advocacy" for their employees, to include putting them in touch with nurses and specialists on demand, coordinating their care, and providing the best resources for their individual needs. Mention "company health care plan" to most employees and they will picture a byzantine system which includes long lines on hold and inexplicable bills arriving in the mail. Accolade turns that model on its head. We place a fair value of $60 on the shares. At $2.8 billion in size, the firm has plenty of room to grow.
Answer
Three Polish-Jewish siblings founded Hassenfeld Brothers in 1923, selling textile remnants, then school supplies, then—ultimately—toys. They would later shorten the name to Hasbro. The brothers' first hit toy came along in 1952 in the form of a lumpy brownish potato; included in the kit were hands, feet, ears, two mouths, two pairs of eyes, four noses, three hats, eyeglasses, a pipe, and some felt which resembled facial hair.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Hasbro's first hit toy...
Hasbro can trace its roots back to 1923, but its first major hit rolled along in 1952. What was that beloved toy?
Penn Trading Desk:
Penn: Add media conglomerate to the Intrepid
Just because we are not fans of a company doesn't mean we can't make money off of it. That is the scenario under which we picked up shares of a media giant whose price rose too quickly, then fell too sharply. The ideal place for a company we don't love—or even necessarily like? Anyone following the five Penn strategies knows there is only one good fit: the Penn Intrepid Trading Platform. Our target price is precisely 50% above where we purchased the shares. For details of the trade, sign into the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Global Strategy: Southeast Asia
10. In a refreshing move, Western companies are finally speaking out against China's horrendous human rights abuses
In the current zeitgeist, many large American companies seem to have no problem wading into domestic politics—a taboo policy until quite recently. Now, in a refreshing move, some surprising players are finally willing to shine a light on the human rights abuses committed by the Communist Party of China. The largest footwear and athletic apparel brand in the world, Nike (NKE $133), saw its shares take a hit last week after the company denounced the forced labor of Chinese Uyghers and other ethnic minorities throughout various parts of China. Swedish fashion conglomerate H&M (HMRZF $24) announced that it would stop buying cotton from the Xinjiang region of northwest China after confirmed reports of forced labor. Burberry, Adidas, and New Balance have issued similar statements condemning the conditions. In another refreshing move, the governments of the EU, the UK, the US, and Canada jointly issued a statement denouncing the treatment of minorities in China. Now, as could be expected, calls to boycott Nike and H&M have sprung up across China. As the communist party controls virtually every aspect of media—to include social media—within China, the boycotts could have been easily predicted. How badly could these companies be hurt by a boycott? Considering that 36% of Nike's production and 22% of the company's sales emanate from China, there will be some pain felt. However, this should serve as an excellent wake up call for organizations which have become overly reliant on one closed society's cheap labor and growing middle class. Perhaps they will now consider China's more open-society neighbors to the south and east as a location for new plants and for new sources of revenue.
It has been widely reported that China is turning more towards Russia and North Korea as it faces ever-increasing blowback for its unacceptable actions. That shouldn't come as a surprise, considering the similar nature of all three governments. The importance of US leadership in building an international alliance against human rights atrocities cannot be overstated. As the world's largest economy, America must counter China's Belt and Road Initiative (BRI), which will serve as a spreader for these practices, by building stronger economic and political alliances with countries around the world instead of acting unilaterally.
Capital Markets
09. We knew several major media and entertainment stocks fell sharply, now we begin to see the formerly-unknown fallout
In the matter of a week, former high-flying media darlings Discovery (DISCA $42) and ViacomCBS (VIAC $46) saw there share prices slashed roughly in half, without any clear-cut catalyst. Investors saw that bloodbath unfold in real time, but something else was going on behind the scenes which was neither clear nor transparent. One family office group (FOG), Archegos Capital, founded by former Tiger Management analyst Bill Hwang, had amassed major stakes in both of these firms and a number of Chinese Internet ADRs. As the shares began to crater, margin calls began rolling in from Archegos lenders, primarily Credit Suisse and Nomura, forcing the FOG to sell shares—thus exacerbating the initial drop. Both of these foreign lenders warned of big losses after announcing that "a significant US-based hedge fund had defaulted on margin calls," causing the shares of each to drop around 13%. It is too early to tell just how much Archegos and its lenders have lost in this nightmarish downward spiral, but it will certainly be in the billions of dollars for each of the players. Of interesting note: Goldman Sachs, Morgan Stanley, and Deutsche Bank rapidly unloaded big blocks of shares last week which were tied to Archegos. In other words, they got out before incurring the losses felt by Credit Suisse and Nomura. The incident is especially troubling for Credit Suisse, which already faced massive losses from the collapse of UK investment partner Greensill Capital, and a reported February loss of over $1 billion stemming from a US court case over questionable securities.
Here is what's most disturbing about this case: Neither Credit Suisse nor Nomura shareholders were wise to the banks' dealings with Archegos or the extent to which the hedge fund had leveraged its media holdings. This is due to an exclusion made for family office groups in Dodd-Frank legislation, exempting them from the the same level of SEC reporting with which non-FOGs must comply. Odds are extremely high that by the time the dust settles on this saga these rules will have been "amended."
Science & Technology Investor
08. Cathie Wood's ARK Space Exploration & Innovation ETF makes its debut
To say that Cathie Wood, founder, CEO, and CIO of ARK Investment Management, has made a big splash in the investment world is an understatement. Her skills at uncovering and investing in primarily small- and mid-cap tech and innovation companies (and increased marketing, of course) have led to a stunning inflow of funds during a horrendously tough year—her firm's assets under management (AUM) went from around $2.6 billion to over $50 billion. This week, Wood launched her latest gem: the ARK Space Exploration and Innovation ETF (ARKX $20). The fund, according to ARK, will invest in companies operating under one of four areas: orbital aerospace, suborbital aerospace, enabling technologies, and aerospace beneficiaries (e.g. Internet access). The top holding (of around 50) is scientific and technical instruments maker Trimble (TRMB $78); others in the top-ten list include Kratos Defense & Security (KTOS), L3 Harris Technologies (LHX), and Iridium Communications (IRDM). It would be safe to assume that SpaceX will be among the holdings when that company ultimately goes public. I must admit to being excited about this fund, and appreciate the company's complete transparency with respect to buys and sells—what a refreshing concept.
Based on the explosive growth in all things tech and space related as of late, is this fund overvalued out of the gate? I don't believe so. Looking through the holdings, many are industrial or tech names which are not on most investors' radar screens. It is an impressive lineup.
Economics: Work & Pay
07. A spectacular jobs report pushes equities higher
Yes, yes, we know it will take like ten more jobs reports similar to the one we got for March to get us back anywhere near where we were in February of 2020, but let's take some time and savor this one. While the markets were closed on Good Friday, futures shot up nonetheless on news that the US added 916,000 new jobs in the month of March against economists' expectations for 618,000. Even better, the hiring was broad-based, spread out among virtually every corner of the private sector. Notable strength was seen in leisure and hospitality (the group hit hardest during the heart of the pandemic), education, health care, and construction. The US unemployment rate dropped from 6.2% to 6%, while the more comprehensive U-6 rate (which includes all persons marginally attached to the labor force) dropped from 11.1% to 10.7%. Even better than simply a stunning report, the areas of weakness (such as wages) gave investors confidence that the Fed wouldn't accelerate plans to raise rates. Even after digesting the news for three days, investors were still applauding the report on Monday morning, as all major indexes rose in excess of 1% out of the gates.
Warmer weather, more vaccines, strong hiring—we can feel the momentum building. Out litmus test for the great economic comeback will be full NFL stadiums this fall; and yes, we expect that to be the case. Our dual goals, post-pandemic? More "shop local," and less "Made in China."
Market Pulse
06. Jamie Dimon sees economic boom continuing into 2023, but also sees challenges to address
In his annual letter to JP Morgan (JPM $153) shareholders, CEO Jamie Dimon said he sees strong growth for the American economy "easily running into 2023." Dimon, one of the most astute watchers of the market, listed a host of factors for his bullish sentiment on the world's largest economy: the remarkable speed at which a vaccine was developed, excess savings for the typical American family after being homebound for much of the past year, huge deficit spending, more quantitative easing by the Fed, a new infrastructure bill, and general euphoria that the long global nightmare may finally be coming to an end. His letter wasn't all rosy, however. Dimon sees a real possibility that inflation "will not be just temporary," and he expressed his concerns that our international rivals see a nation "torn and crippled by politics...." "The good news," Dimon concluded, "is that this is fixable."
There have always been fomenters of discord and division in this country. There is no doubt that our adversaries, such as China and Russia, are stealthily acting to support such hatred and division. America is, by far, the strongest nation on earth, both economically and militarily—that is a statistically provable fact, not hyperbole. The best weapon our enemies have to harm our standing in the world is to help balkanize the country into groups pitted against one another. Their efforts will fail if we refuse to play their game.
Application & Systems Software
05. Another smart move by Satya Nadella: Microsoft to buy AI firm Nuance in $19.7 billion deal
CEO Satya Nadella continues to aggressively transform Microsoft (MSFT $255), with his latest move being the acquisition of pioneering speech-recognition ("conversational AI") company Nuance (NUAN) for $19.7 billion ($16 billion plus assumption of debt). The all-cash deal values Nuance at $56 per share, or a 23% premium over Friday's close. The move should give Microsoft a greater presence in the growing field of health information services, and should also be cause for concern for the likes of $22 billion, Missouri-based Cerner (CERN $73). Nuance offers health care professionals the tools to recognize and transcribe speech during doctor's visits, both in-person and digital (telemedicine). Appointment management, patient support, and the efficient creation and maintenance of complete medical records are a few of Nuance's extensive list of offerings. While health care is the leading source the firm's revenues, it also operates in the financial services, telecom, retail, and government sectors. The deal would represent Microsoft's second-largest ever, behind only the 2016 acquisition of LinkedIn for $27 billion.
Microsoft is one of the forty holdings within the Penn Global Leaders Club, and remains one of our strongest-conviction buys at its current price.
Global Strategy: Europe
04. Could an internecine battle in Germany help bring about a major regime change?
For some reason, it seems as though it has been about five years since Angela Merkel announced that she would be stepping down from her role as Chancellor of Germany—a position (stepping down, that is) rather forced upon her by the party she led between 2000 and 2018, the Christian Democratic Union (CDU). In what seems to be dragging on longer than Brexit, the battle for her successor just took a dramatic turn.
While there are roughly a dozen political parties in the country, the ruling alliance between the center-right CDU and the center-right Christian Social Union in Bavaria (CSU) has been a stabilizing factor in the country since nearly the end of World War II. Generally, the leader of the larger CDU, Merkel's party, gets the nod to represent the alliance in the national election. And, indeed, Merkel has backed her party's leader, Armin Laschet, to succeed her. However, the more charismatic Markus Söder, head of the CSU, believes that he is the right person for the job, and his party just sent a shocking snub to Merkel's pick. Söder points out how far the CDU has fallen in the polls since the former journalist took the reins of the party from Merkel three years ago. He is correct on both counts: that the party has fallen from grace since 2018, and that he could energize the electorate more than Laschet.
Of course, this battle has the center-left Social Democratic Party of Germany (SPD) licking its chops. It sees its own nominee, Olaf Scholz, gaining from the disarray. To further complicate the matter, Scholz is not only Merkel's deputy vice chancellor, he actually lost the race to be the leader of his own party. We won't even get into the far-left Green Party, or the far-right Alternative for Germany (AfD), or even the Pirate Party, which opposes the EU's data retention policies. It should be fun to watch (from across the ocean) as battles play out over the next five months—the country has set its official federal election date as 26 September 2021.
The ugliness could spiral out of control, with a real possibility that Scholz could pull out a victory. Considering the gargantuan problems facing Germany right now, perhaps the real question should be why would anyone want to be chancellor?
Cryptocurrencies
03. There is an enormous crypto opportunity coming Wednesday via direct listing; should you buy?
If we ever had any doubts about the long-term viability of cryptos, that ended when it became clear that China has plans to create its own global reserve currency (dollar envy). It has decided to do that in the form of a government-backed digital currency, a sovereign Bitcoin if you will. Technically called the Digital Currency Electronic Payment, or DCEP, the currency will allow the Communist Party of China to further control the entire banking system in China and, in the hopes and dreams of the master planners, create a tool to overtake the dollar as the world's reserve currency. Will it work? Probably not—at least not to the extent China hopes. However, it points to the critical importance of the American government both understanding and embracing cryptos.
On that note, Something big will happen in the crypto world on Wednesday: Coinbase will go public via a direct listing. As the largest cryptocurrency exchange, the San Fran-based company (though it has no official physical headquarters) acts as a secure online platform for buying, selling, transferring, and storing digital currency. The fact that it is part of the support structure, rather than an entity tied to the success of any one single crypto such as Bitcoin, makes the company extremely interesting. Not only that, it is (get ready) already profitable! The firm had a blowout Q1, with earning of around $800 million on revenues of $7.2 billion. And that revenue base represented an 850% spike from the same quarter a year earlier. There is only one problem with this intriguing investment. With the rabid interest circulating around cryptos and the millions of new myopic retail investors now in the game, Coinbase will probably come out of the chute with a market cap in excess of $100 billion, and some will be willing to jump in at any price ("diamond hands, baby"). We will be watching the action closely, and if the price is too expensive on its first day of trading we recommend investors wait for the shares to come down and settle within a reasonable range.
Cryptos, despite what we said about their inevitable future, still operate in a normal market cycle of peaks, contractions, troughs, and expansions. Don't get too caught up in the hype: when everyone is jumping into the water with their eyes closed, it is always wise advice to wait until the sharks send them fleeing for safety.
Media & Entertainment
02. Physical games meet digital gaming as Roblox and Hasbro team up
Last month we wrote about the exciting new (to the markets) online entertainment platform Roblox (RBLX $83), which allows users to code their own games and share them for other gamers to play—often earning a little profit in the process. One 98-year-old gaming company which few associate with technology, Hasbro (HAS $99), is hoping to breathe some new life into its lineup by joining forces with the online platform. Specifically, the toy and game company's Nerf and Monopoly lines will soon include codes for Roblox players to redeem for virtual items. Additionally, a number of Roblox games will be created around the iconic products. For example, buy a Nerf Blaster and receive a code to score an online Nerf Blaster to use in games such as Jailbreak and Arsenal. A new version of Monopoly, to be available later this year, will include Roblox characters and come with codes to acquire other online items. We're not sure which company came up with the brainstorm, but if it was Hasbro's idea, it is the latest in a series of smart moves. Recall that five years ago the company scored a major coup in taking the Disney line away from Mattel (MAT $20) after a sixty year relationship was fractured. For an old-school toy company living in a digital world, Hasbro continues to impress.
The ten-year chart of Hasbro vs Mattel highlights the great struggle between the two iconic brands. Some analysts still believe that $14 billion Hasbro should acquire Mattel, half its size. There is little doubt that the former is leading the latter in digital acumen; plus, who wouldn't want to own the coveted Barbie and American Girl lines?
Under the Radar Investment
01. Accolade Inc
There are many corners of the health care market with which investors are enamored, from big pharma to biotech to medical devices and testing, but one area which remains relatively ignored is the health information services arena. The industry made news this week with Microsoft's announcement that it would buy Nuance in a nearly $20 billion deal, but a firm much deeper under the radar screen of investors is $2.8 billion Accolade Inc (ACCD $48). Accolade is a tech-based firm which helps employers provide individualized health care "advocacy" for their employees, to include putting them in touch with nurses and specialists on demand, coordinating their care, and providing the best resources for their individual needs. Mention "company health care plan" to most employees and they will picture a byzantine system which includes long lines on hold and inexplicable bills arriving in the mail. Accolade turns that model on its head. We place a fair value of $60 on the shares. At $2.8 billion in size, the firm has plenty of room to grow.
Answer
Three Polish-Jewish siblings founded Hassenfeld Brothers in 1923, selling textile remnants, then school supplies, then—ultimately—toys. They would later shorten the name to Hasbro. The brothers' first hit toy came along in 1952 in the form of a lumpy brownish potato; included in the kit were hands, feet, ears, two mouths, two pairs of eyes, four noses, three hats, eyeglasses, a pipe, and some felt which resembled facial hair.
Headlines for the Week of 21 Mar—27 Mar 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Correction: The Penn Wealth Report, Vol. 9 Issue 02
In the "From the Editor" section of the latest Penn Wealth Report it was mistakenly noted that the Nasdaq began its massive 78% drop sixteen years ago this month. This should have read "twenty-one years ago this month." The publication has been updated.
Question
The first video blockbuster...
For some reason, the Roblox image made us think of the early days of video games. On that note, what was the first blockbuster video game (which seemed so futuristic at the time), and when was it released?
Penn Trading Desk:
ARK Invest: Tesla going to $3,000
Cathie Wood's ARK Invest ETFs have taken the investment world by storm. From the ARK Industrial Innovation fund to the ARK Genomic Revolution, she has quickly built a reputation of being an oracle for emerging technologies. Her bold call this week on where Tesla (TSLA $670) is headed raised some eyebrows, along with the price of the shares. She sees the leading EV maker's shares headed to $3,000 by 2025, which would give the firm a market cap in the neighborhood of $3.5 trillion. While $3,000 is ARK's base case for TSLA, they did list a 2025 bear case price of $1,500 per share. One big catalyst for the price jump, Wood argues, is the potential for a large fleet of robotaxis hitting the streets over the coming five years, which she sees Tesla spearheading. With the shares off around 5% for the year, at $670, true believers should probably see this as an opportunity to jump in—or add to their position.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecom Services
10. AT&T is finally spinning off its satellite and cable TV services
Back in 2015, telecom giant AT&T (T $30) acquired satellite television service provider DirecTV for $66 billion ($49B plus debt), thus beginning a comical boondoggle for the firm. Finally, six years later, T is offloading the albatross for a fraction of what it paid. More accurately, the company is spinning off its satellite and cable operations into a new company with the help of private equity group TPG Capital, which will pay nearly $8 billion in cash to become a minority owner. The new entity will hold DirecTV, AT&T TV (the firm's cord-cutting attempt), and U-Verse (which it left on the vine to die when it bought DirecTV). Fair value of the company sits somewhere around $16 billion, with T owning 70% and TPG owning the remaining 30%. What will management do with the $8 billion windfall? The company said it plans to pay down debt; based on the fact that this $210 billion telecom has approximately $346 billion in short- and long-term debt, that is probably not a bad idea. CEO John Stankey said the move will allow AT&T to focus on "connectivity and content," meaning the 5G wireless, fiber internet, and HBO Max businesses. The deal should close in the second half of this year.
We purchased AT&T in the Penn Strategic Income Portfolio years ago, based primarily on its fat dividend yield and seemingly reasonable price. The dividend yield now sits at 7% and the share price remains flat from where we bought in. Management continues to disappoint, but we still believe a fair value of the shares is around $35, or roughly 20% higher from here.
Cybersecurity
09. A massive Chinese hack hits Microsoft...and some 60,000 of its organizational and corporate customers
While there may not be a "hot" war raging between the United States and both China and Russia, the actions of these two nation-states clearly indicate that they are at battle with this country. What it will take for the United States to get on a war footing is unclear, as thousands of victims continue to fall prey to these adversaries. The latest attack took place within the Microsoft Exchange—a mail and calendar server used by some 200 million individuals and corporations. Unlike the cowardly stance taken by Amazon (AMZN), at least Microsoft has been forthcoming with respect to the attacks made on its systems, and has been willing to identify the culprits to help other companies better protect their customer data.
This latest attack, according to the company, was perpetrated by a Chinese-sponsored group known as Hafnium. This group typically targets infectious disease researchers, defense contractors, and other critical agencies in an effort to both steal knowledge and cause general disruption. Adding insult to injury, the group gets its guidance from the Chinese government but uses servers it leases within the United States. The hackers first gained access to the Exchange by exploiting previously-unknown vulnerabilities, then created a malicious web-based interface to take control of the compromised servers remotely. Finally, they used this remote access to steal data from the targeted individuals and organizations. While Microsoft has identified and patched the vulnerability, the perpetrators already in the "body" may still operate untouched. In other words, they were already on the inside when the patch was put in place.
While a serious federal response is needed, which includes an ongoing series of counterstrikes to send a message, companies and individuals must take responsibility and adopt next-level security practices such as multi-factor authentication and deployment of the highest possible level of cybersecurity protection. Unfortunately, these measures will be irritating and costly, but it sure beats the alternative.
We praise Microsoft for having the guts to be transparent with regard to these attacks, and encourage timid firms like Amazon to follow suit. For investors, cybersecurity—sadly—will be one of the hottest industries for the foreseeable future. We recommend scanning the Penn holding CIBR, the First Trust NASDAQ Cybersecurity ETF, for individual names to consider.
Computer Software/Gaming
08. Roblox is not just another gaming stock, but should you invest?
Admittedly, online gaming stocks don't typically get us very excited from an investment standpoint. Roblox (RBLX $67), however, may just prove to be the exception. Granted, the company came out of the gate with a crazy valuation—it lost $253M on a paltry $924M in revenues in 2020, yet the GameStop crowd made it a $40 billion company by the end of its first day of trading. Want some perspective on that? Ford (F) has a market cap of $49 billion. This particular online entertainment platform, however, has a very unique story. More than just a place to play around (over half of the company's 33 million daily users are 13 or younger), users actually program games and play games created by other users. And it doesn't take a degree in programming to participate: Roblox offers even the youngest of users online tutorials to teach them how to create. "We offer free resources to teach students of all ages real coding, game design, digital civility, and entrepreneurial skills," reads a lead-in to one of their education pages.
Game developers on the platform earn "robux," digital currency which can be created to cold, hard cash. Over 1,250 developers/gamers earned at least $10,000 in robux last year, with several hundred earning over $100,000. Two British teens, who produced their first Roblox game when they were just 13, made a splash in the BBC when it was reported that they paid off their parents mortgage using their converted robux. It doesn't take much to get a large percentage of the younger generation hooked on gaming; imagine what happens when potential to make money is added to the mix. We also appreciate the fact that these young developers are actually learning analytical skills along the way. The shares may seem pricey now (they have dropped back from a high of $79.10), but the company is for real, and it comes with a unique value proposition for investors—unlike GameStop.
There is going to be a substantial tech pullback this year, and we can expect the gaming stocks which are not generating a profit to get hit hard. Where would a decent buy point for RBLX shares reside? If they drop back to $60 or lower, and they fit the respective portfolio mix, it would be wise to take a deeper dive and considering picking some up. In the meantime, why not "sign up and start having fun?" You might even earn some robux while waiting for the shares to become more attractive.
Pharmaceuticals
07. Vaccine Spring: All along, there was only one Covid-19 vaccine we said we would not take
Long before the world knew anything about the Wuhan-borne virus which would rapidly escalate into a global pandemic, we were highly bullish on American pharmaceutical and biotech companies. The more politicians bashed these companies, which create the life-saving medications hundreds of millions of people use annually, the angrier we got. If these politicians had their way, cutting-edge research and development within the pharmaceutical industry would take a major hit—as would the overall health of Americans. Before we work ourselves into a lather once again, let's focus on the incredible progress researchers at these firms made with respect to uncovering a vaccine for the pandemic. With Manhattan Project-like speed, the men and women at these pharma and biotech companies developed, tested, produced, and delivered highly effective therapies to prevent the deadly disease (535,000 Americans have died from Covid as of this writing).
While we would feel comfortable receiving the Pfizer-BioNTech (PFE/BNTX), Moderna (MRNA), or Johnson & Johnson (JNJ) vaccines, we have held serious reservations about one company's efforts from the start. Since early testing began, AstraZeneca PLC's (AZN) vaccine seemed to generate more questions than it answered, and we didn't like the answers management was doling out. Thankfully, the AZN vaccine was never approved for emergency use in the United States, as it was in Europe. Now, three major European countries, Germany, France, and Italy, are joining a rapidly-growing list of nations which have suspended the vaccine following reports of blood clots in the legs and/or lungs of a number of recipients. True to form, the company quickly blasted the suspensions, claiming that the percentage of those vaccinated who developed clots were in line with what could be expected within the general population. It should be noted that a number of those coming down with the conditions resided in younger age groups; i.e., below the age these maladies would typically develop.
The company's objections were reminiscent—at least to us—of their response following the questionable trial results. There never seemed to be a sense of "let's make absolutely sure of this..." so much as "nothing to see here, move along." And that makes us uncomfortable. A lot of nations now seem to feeling ill at ease with the company's vaccine as well. UPDATE: It appears that most of the nations which put a halt on the AstraZeneca vaccines are now willing to lift the temporary bans, mainly due to external pressure. We would still not feel comfortable taking the product, especially as the J&J vaccine begins to flood the market.
AstraZeneca was the result of a 1999 merger between Sweden's Astra and the UK's Zeneca Group. Pfizer's partner BioNTech, it should be noted, is based in Mainz, Germany. We own Pfizer in the Penn Global Leaders Club, and it remains one of our highest-conviction buys.
Global Strategy: Southeast Asia
06. The new administration took a tough stance with China in first official meeting; now, let's look for continuity
Thankfully, John Kerry was nowhere near the Captain Cook Hotel in Anchorage this past week. The first official meeting between the Biden administration and the Communist Party of China was anything but a love-fest, and that gives us encouragement that the US won't get rolled over the next four years. In what was to be a brief photo-op, US Secretary of State Anthony Blinken and US National Security Advisor Jake Sullivan gave their Chinese counterparts an earful, expressing concern over issues from Hong Kong to questionable trade practices to cybersecurity. Secretary Blinken: "...the US relationship with China will be competitive where it should be, collaborative where it can be, adversarial where it must be." He went on to express the concerns raised (about China) from allies such as Japan and South Korea: "I have to tell you what I'm hearing is very different from what you described." Surprisingly stark language for an audience that wanted to hear sycophantic praise for the Chinese people and the ruling communist party. The frustration was revealed in a response by Chinese Director of the Central Foreign Affairs Commission, Yang Jiechi: "...the United States does not have the qualification to say that it wants to speak to China from a position of strength...this is not the way to deal with the Chinese people." A nerve was touched, to put it mildly.
Of course, what really matters is how the Biden administration actually deals with the communist nation going forward. Nonetheless, neither the spirit of Neville Chamberlain nor John Kerry seemed to be present in the room—which gives us quite a bit of comfort.
One of our biggest beefs with the Trump administration was the lack of willingness to join with our allies in a united front against unacceptable Chinese behavior. We are virtually certain that will not be the case with the new administration. China also made a major miscalculation by unleashing the massive cyber strike against Microsoft so early in Biden's term, leaving him almost no choice but to take a tough stance against our major global nemesis. Russia is trying to join forces with China against the US on several fronts, such as a planned Sino-Russian moon base, but Russia remains a shell of its former self, with an economy fueled—no pun intended—overwhelmingly by fossil fuels. A full 82% of the world's population does not reside in China, and a majority of that percentage hold animosity for—or, at least, a deep mistrust of—China. The US must work to garner a true global coalition against the CCP's global ambitions. We can't think of any more important strategic US focus over the coming years.
Road & Rail
05. America is losing one of its great and storied railroads as Canadian Pacific set to acquire Kansas City Southern
It has been twelve years since Warren Buffett's "affinity for railroads as a kid" led him to take a great American rail, Burlington Northern Santa Fe, private, and we still aren't over it—BNI was one of our favorite holdings in the Penn Global Leaders Club. Now, investors are about to lose another great name in the space: Canadian Pacific (CP $370) plans to acquire Kansas City Southern (KSU $260) for $25 billion plus the assumption of roughly $4 billion in debt. As a north-south rail, Kansas City Southern has been a major play on trade between the United States and Mexico: the firm owns 3,400 route miles in the US, and an interest in 3,300 miles of rail in Mexico. Canadian Pacific is a $50 billion rail which operates 12,500 miles of track throughout most of Canada and into parts of the Northeastern and Midwestern US. While it will be tough to say goodbye to KSU, the deal actually makes a lot of sense. As Canada became the last nation to approve the new USMCA trade pact last March, the new rail will be a beast, controlling a north-south route throughout the pact's domain. For the first time ever, one rail will connect all three nations. Current CP CEO Keith Creel will head up the new giant, which will be based out of Calgary, Alberta. At least investors will still have the ability to own Kansas City Southern, albeit through CP shares—last fall the rail rejected a $208/share bid from the Blackstone Group which would have taken the firm private.
Although there will be a regulatory fight, this acquisition will ultimately be approved. If the USMCA lives up to its potential, Canadian Pacific will be in a great position to streamline its operations, improve profitability, and grow its market share. While we don't own CP, we are bullish on the shares, which currently sit around $370.
Monetary Policy
04. The Fed calmed market fears last week, but its growing balance sheet is concerning
Fed Chair Jerome Powell said just about everything right at his Q&A following last week's FOMC meeting. The Fed upgraded its US GDP expectations for the year from 4.2% to 6.5%; inflation may well go above 2% in the short-term, but that was OK; and the central bank would continue buying bonds at a clip of $120 billion per month. The markets may have cheered the news, but the rising debt load of the Fed, which is part of the nation's $28 trillion overall debt load, is concerning. Before the 2008 financial crisis, the Fed's balance sheet was below $1 trillion. It more than doubled due to the crisis, then plateaued around $2.8 trillion before mushrooming again in 2013 and 2014. Steady at about $4.5 trillion for several years, it did something few would expect: it began falling—all the way back down to $3.6 trillion in September of 2019. Of course, we know what hit the world six months later, causing the balance sheet to more than double. Just shy of $8 trillion now, we can expect (based on Powell's comments) that it will hit $9 trillion before any talk of tapering. Of major note at the FOMC meeting was the fact that only four members saw rates rising in 2022 and another eight (of the eighteen) saw rates coming off of zero in 2023. That is remarkable, at least until we consider that every tick up in rates makes servicing our $28 trillion national debt all the costlier. At least we are not alone in the boat; governments around the world are awash in debt, with few showing signs of hiking rates. In the meantime, let the party continue.
For the first time in a year, the pandemic is not the market's biggest concern—and that is wonderful news. Right now, investors have turned their attention to inflation and Treasury rates creeping up. Our biggest concern right now is none of the above. We see valuations reaching crazy levels on some high-flying tech names which won't turn a profit for years. There will be a tech reckoning at some point this year, which is one reason we have been maneuvering toward a value tilt. Also, portfolios simply got overweighted in growth names due to the run-up. This spring is certainly a good time for a portfolio tune-up.
Auto Parts
03. Goodyear to buy Cooper Tire & Rubber Company for $2.8 billion
There aren't many tire manufacturers based in the United States these days, so the two biggest might as well join forces. Goodyear Tire & Rubber Company (GT $17) has announced its plans to acquire smaller US rival Cooper Tire (CTB) for $2.8 billion in cash and stock. Goodyear, which trails only France's Michelin and Japan's Bridgestone by sales, will suddenly have a much larger global footprint: 50 factories and 72,000 employees around the world, and sales volume of 64 million replacement tires in the US. With demand for replacement tires expected to grow rapidly in the coming years, the move should allow the new entity to grow market share substantially in both the US and China—the industry's two largest markets. Both companies are based out of Ohio.
Obviously, the commodity price of rubber plays a major role in a tire manufacturer's bottom line. Fortunately, global rubber prices have dropped precipitously over the past decade. We would put a fair value on the price of Goodyear shares, post-merger, at $20.
Business & Professional Services
02. Will GoPuff be the poster child for the coming post-pandemic market reality check?
For anyone not familiar with SoftBank, it is the Masayoshi Son-run business that tried to bring WeWork public with founder and walking nightmare Adam Neumann still at the helm (at least originally). For anyone not familiar with GoPuff, it is yet another delivery service which brings products from the store to your home. The latter is being financially backed, in good measure, by the former. Why, you might ask, does America need another delivery service with established competitors such as Amazon, DoorDash, Uber Eats, GrubHub, Walmart, Drizly, Instacart, and an army of grocery stores which are getting into the game? We wish we had the answer. As for their unique value proposition (UVP), the delivery service brings household items such as OTC medicines, snacks, and household essentials to your doorstep. In essence, you are saved that pesky trip to Walgreens. (Actually, don't some of these competitors already do that?)
Forget the viability—or lack thereof—of the company's UVP; we are more concerned about the valuation. In October of 2020, the company raised funds which valued the enterprise at just under $4 billion. Now, fueled with a new round of funding, it is valued at just shy of $9 billion. Keep this in mind as well: GoPuff will probably go public this year, and we have all seen what happens to these novelty (our word) startups out of the gate—many see their shares double or even triple before the dust settles. So, we have a company that may be worth $4 billion (doubt it), it is now valued at $9 billion, and it may be at $20 billion after the IPO. Does that make sense? We love DoorDash, but how many DASH investors even realize that the firm, which has never turned a profit, has a $44 billion market cap as of this writing? There is a house of cards being built, and every house of cards eventually comes crashing down.
Forget the hype being pushed by the old media or on social media with respect to these companies. Do the research, figure out whether they actually do have a UVP, take a look at the numbers, consider the management team in place, and make wise investment decisions based on the easily-accessible research available to virtually everyone. Maybe it is FOMO, or maybe we are simply going stir-crazy in our homes, but there is a whole lot of gambling going on within the markets right now.
Under the Radar Investment
01. Adaptive Biotechnologies Corp
Adaptive Biotechnology Corp (ADPT $42) is a $6 billion biotech firm working in the field of what they refer to as Immune Medicine. By harnessing the power of the adaptive immune system, a subsystem which contains processes that eliminate pathogens or prevent their growth, the company believes it can transform the diagnosis and treatment of disease. The company's clinical diagnostic product, clonoSEQ, is an FDA-authorized test for the detection and monitoring of minimal residual disease in patients with blood cancers. The cornerstone of Adaptive's Immune Medicine platform, immunoSEQ, serves as its underlying R&D engine and generates revenue from academic and biopharmaceutical customers. Shares have dropped from their $71.25 high reached on 25 Jan 2021.
Answer
Space Invaders, created in 1978 by Tomohiro Nishikado, was licensed in the US by the Midway division of Bally. By 1982, the game had grossed nearly $4 billion, making it both the best-selling and highest-grossing (adjusted for inflation) video game of all time.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Correction: The Penn Wealth Report, Vol. 9 Issue 02
In the "From the Editor" section of the latest Penn Wealth Report it was mistakenly noted that the Nasdaq began its massive 78% drop sixteen years ago this month. This should have read "twenty-one years ago this month." The publication has been updated.
Question
The first video blockbuster...
For some reason, the Roblox image made us think of the early days of video games. On that note, what was the first blockbuster video game (which seemed so futuristic at the time), and when was it released?
Penn Trading Desk:
ARK Invest: Tesla going to $3,000
Cathie Wood's ARK Invest ETFs have taken the investment world by storm. From the ARK Industrial Innovation fund to the ARK Genomic Revolution, she has quickly built a reputation of being an oracle for emerging technologies. Her bold call this week on where Tesla (TSLA $670) is headed raised some eyebrows, along with the price of the shares. She sees the leading EV maker's shares headed to $3,000 by 2025, which would give the firm a market cap in the neighborhood of $3.5 trillion. While $3,000 is ARK's base case for TSLA, they did list a 2025 bear case price of $1,500 per share. One big catalyst for the price jump, Wood argues, is the potential for a large fleet of robotaxis hitting the streets over the coming five years, which she sees Tesla spearheading. With the shares off around 5% for the year, at $670, true believers should probably see this as an opportunity to jump in—or add to their position.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecom Services
10. AT&T is finally spinning off its satellite and cable TV services
Back in 2015, telecom giant AT&T (T $30) acquired satellite television service provider DirecTV for $66 billion ($49B plus debt), thus beginning a comical boondoggle for the firm. Finally, six years later, T is offloading the albatross for a fraction of what it paid. More accurately, the company is spinning off its satellite and cable operations into a new company with the help of private equity group TPG Capital, which will pay nearly $8 billion in cash to become a minority owner. The new entity will hold DirecTV, AT&T TV (the firm's cord-cutting attempt), and U-Verse (which it left on the vine to die when it bought DirecTV). Fair value of the company sits somewhere around $16 billion, with T owning 70% and TPG owning the remaining 30%. What will management do with the $8 billion windfall? The company said it plans to pay down debt; based on the fact that this $210 billion telecom has approximately $346 billion in short- and long-term debt, that is probably not a bad idea. CEO John Stankey said the move will allow AT&T to focus on "connectivity and content," meaning the 5G wireless, fiber internet, and HBO Max businesses. The deal should close in the second half of this year.
We purchased AT&T in the Penn Strategic Income Portfolio years ago, based primarily on its fat dividend yield and seemingly reasonable price. The dividend yield now sits at 7% and the share price remains flat from where we bought in. Management continues to disappoint, but we still believe a fair value of the shares is around $35, or roughly 20% higher from here.
Cybersecurity
09. A massive Chinese hack hits Microsoft...and some 60,000 of its organizational and corporate customers
While there may not be a "hot" war raging between the United States and both China and Russia, the actions of these two nation-states clearly indicate that they are at battle with this country. What it will take for the United States to get on a war footing is unclear, as thousands of victims continue to fall prey to these adversaries. The latest attack took place within the Microsoft Exchange—a mail and calendar server used by some 200 million individuals and corporations. Unlike the cowardly stance taken by Amazon (AMZN), at least Microsoft has been forthcoming with respect to the attacks made on its systems, and has been willing to identify the culprits to help other companies better protect their customer data.
This latest attack, according to the company, was perpetrated by a Chinese-sponsored group known as Hafnium. This group typically targets infectious disease researchers, defense contractors, and other critical agencies in an effort to both steal knowledge and cause general disruption. Adding insult to injury, the group gets its guidance from the Chinese government but uses servers it leases within the United States. The hackers first gained access to the Exchange by exploiting previously-unknown vulnerabilities, then created a malicious web-based interface to take control of the compromised servers remotely. Finally, they used this remote access to steal data from the targeted individuals and organizations. While Microsoft has identified and patched the vulnerability, the perpetrators already in the "body" may still operate untouched. In other words, they were already on the inside when the patch was put in place.
While a serious federal response is needed, which includes an ongoing series of counterstrikes to send a message, companies and individuals must take responsibility and adopt next-level security practices such as multi-factor authentication and deployment of the highest possible level of cybersecurity protection. Unfortunately, these measures will be irritating and costly, but it sure beats the alternative.
We praise Microsoft for having the guts to be transparent with regard to these attacks, and encourage timid firms like Amazon to follow suit. For investors, cybersecurity—sadly—will be one of the hottest industries for the foreseeable future. We recommend scanning the Penn holding CIBR, the First Trust NASDAQ Cybersecurity ETF, for individual names to consider.
Computer Software/Gaming
08. Roblox is not just another gaming stock, but should you invest?
Admittedly, online gaming stocks don't typically get us very excited from an investment standpoint. Roblox (RBLX $67), however, may just prove to be the exception. Granted, the company came out of the gate with a crazy valuation—it lost $253M on a paltry $924M in revenues in 2020, yet the GameStop crowd made it a $40 billion company by the end of its first day of trading. Want some perspective on that? Ford (F) has a market cap of $49 billion. This particular online entertainment platform, however, has a very unique story. More than just a place to play around (over half of the company's 33 million daily users are 13 or younger), users actually program games and play games created by other users. And it doesn't take a degree in programming to participate: Roblox offers even the youngest of users online tutorials to teach them how to create. "We offer free resources to teach students of all ages real coding, game design, digital civility, and entrepreneurial skills," reads a lead-in to one of their education pages.
Game developers on the platform earn "robux," digital currency which can be created to cold, hard cash. Over 1,250 developers/gamers earned at least $10,000 in robux last year, with several hundred earning over $100,000. Two British teens, who produced their first Roblox game when they were just 13, made a splash in the BBC when it was reported that they paid off their parents mortgage using their converted robux. It doesn't take much to get a large percentage of the younger generation hooked on gaming; imagine what happens when potential to make money is added to the mix. We also appreciate the fact that these young developers are actually learning analytical skills along the way. The shares may seem pricey now (they have dropped back from a high of $79.10), but the company is for real, and it comes with a unique value proposition for investors—unlike GameStop.
There is going to be a substantial tech pullback this year, and we can expect the gaming stocks which are not generating a profit to get hit hard. Where would a decent buy point for RBLX shares reside? If they drop back to $60 or lower, and they fit the respective portfolio mix, it would be wise to take a deeper dive and considering picking some up. In the meantime, why not "sign up and start having fun?" You might even earn some robux while waiting for the shares to become more attractive.
Pharmaceuticals
07. Vaccine Spring: All along, there was only one Covid-19 vaccine we said we would not take
Long before the world knew anything about the Wuhan-borne virus which would rapidly escalate into a global pandemic, we were highly bullish on American pharmaceutical and biotech companies. The more politicians bashed these companies, which create the life-saving medications hundreds of millions of people use annually, the angrier we got. If these politicians had their way, cutting-edge research and development within the pharmaceutical industry would take a major hit—as would the overall health of Americans. Before we work ourselves into a lather once again, let's focus on the incredible progress researchers at these firms made with respect to uncovering a vaccine for the pandemic. With Manhattan Project-like speed, the men and women at these pharma and biotech companies developed, tested, produced, and delivered highly effective therapies to prevent the deadly disease (535,000 Americans have died from Covid as of this writing).
While we would feel comfortable receiving the Pfizer-BioNTech (PFE/BNTX), Moderna (MRNA), or Johnson & Johnson (JNJ) vaccines, we have held serious reservations about one company's efforts from the start. Since early testing began, AstraZeneca PLC's (AZN) vaccine seemed to generate more questions than it answered, and we didn't like the answers management was doling out. Thankfully, the AZN vaccine was never approved for emergency use in the United States, as it was in Europe. Now, three major European countries, Germany, France, and Italy, are joining a rapidly-growing list of nations which have suspended the vaccine following reports of blood clots in the legs and/or lungs of a number of recipients. True to form, the company quickly blasted the suspensions, claiming that the percentage of those vaccinated who developed clots were in line with what could be expected within the general population. It should be noted that a number of those coming down with the conditions resided in younger age groups; i.e., below the age these maladies would typically develop.
The company's objections were reminiscent—at least to us—of their response following the questionable trial results. There never seemed to be a sense of "let's make absolutely sure of this..." so much as "nothing to see here, move along." And that makes us uncomfortable. A lot of nations now seem to feeling ill at ease with the company's vaccine as well. UPDATE: It appears that most of the nations which put a halt on the AstraZeneca vaccines are now willing to lift the temporary bans, mainly due to external pressure. We would still not feel comfortable taking the product, especially as the J&J vaccine begins to flood the market.
AstraZeneca was the result of a 1999 merger between Sweden's Astra and the UK's Zeneca Group. Pfizer's partner BioNTech, it should be noted, is based in Mainz, Germany. We own Pfizer in the Penn Global Leaders Club, and it remains one of our highest-conviction buys.
Global Strategy: Southeast Asia
06. The new administration took a tough stance with China in first official meeting; now, let's look for continuity
Thankfully, John Kerry was nowhere near the Captain Cook Hotel in Anchorage this past week. The first official meeting between the Biden administration and the Communist Party of China was anything but a love-fest, and that gives us encouragement that the US won't get rolled over the next four years. In what was to be a brief photo-op, US Secretary of State Anthony Blinken and US National Security Advisor Jake Sullivan gave their Chinese counterparts an earful, expressing concern over issues from Hong Kong to questionable trade practices to cybersecurity. Secretary Blinken: "...the US relationship with China will be competitive where it should be, collaborative where it can be, adversarial where it must be." He went on to express the concerns raised (about China) from allies such as Japan and South Korea: "I have to tell you what I'm hearing is very different from what you described." Surprisingly stark language for an audience that wanted to hear sycophantic praise for the Chinese people and the ruling communist party. The frustration was revealed in a response by Chinese Director of the Central Foreign Affairs Commission, Yang Jiechi: "...the United States does not have the qualification to say that it wants to speak to China from a position of strength...this is not the way to deal with the Chinese people." A nerve was touched, to put it mildly.
Of course, what really matters is how the Biden administration actually deals with the communist nation going forward. Nonetheless, neither the spirit of Neville Chamberlain nor John Kerry seemed to be present in the room—which gives us quite a bit of comfort.
One of our biggest beefs with the Trump administration was the lack of willingness to join with our allies in a united front against unacceptable Chinese behavior. We are virtually certain that will not be the case with the new administration. China also made a major miscalculation by unleashing the massive cyber strike against Microsoft so early in Biden's term, leaving him almost no choice but to take a tough stance against our major global nemesis. Russia is trying to join forces with China against the US on several fronts, such as a planned Sino-Russian moon base, but Russia remains a shell of its former self, with an economy fueled—no pun intended—overwhelmingly by fossil fuels. A full 82% of the world's population does not reside in China, and a majority of that percentage hold animosity for—or, at least, a deep mistrust of—China. The US must work to garner a true global coalition against the CCP's global ambitions. We can't think of any more important strategic US focus over the coming years.
Road & Rail
05. America is losing one of its great and storied railroads as Canadian Pacific set to acquire Kansas City Southern
It has been twelve years since Warren Buffett's "affinity for railroads as a kid" led him to take a great American rail, Burlington Northern Santa Fe, private, and we still aren't over it—BNI was one of our favorite holdings in the Penn Global Leaders Club. Now, investors are about to lose another great name in the space: Canadian Pacific (CP $370) plans to acquire Kansas City Southern (KSU $260) for $25 billion plus the assumption of roughly $4 billion in debt. As a north-south rail, Kansas City Southern has been a major play on trade between the United States and Mexico: the firm owns 3,400 route miles in the US, and an interest in 3,300 miles of rail in Mexico. Canadian Pacific is a $50 billion rail which operates 12,500 miles of track throughout most of Canada and into parts of the Northeastern and Midwestern US. While it will be tough to say goodbye to KSU, the deal actually makes a lot of sense. As Canada became the last nation to approve the new USMCA trade pact last March, the new rail will be a beast, controlling a north-south route throughout the pact's domain. For the first time ever, one rail will connect all three nations. Current CP CEO Keith Creel will head up the new giant, which will be based out of Calgary, Alberta. At least investors will still have the ability to own Kansas City Southern, albeit through CP shares—last fall the rail rejected a $208/share bid from the Blackstone Group which would have taken the firm private.
Although there will be a regulatory fight, this acquisition will ultimately be approved. If the USMCA lives up to its potential, Canadian Pacific will be in a great position to streamline its operations, improve profitability, and grow its market share. While we don't own CP, we are bullish on the shares, which currently sit around $370.
Monetary Policy
04. The Fed calmed market fears last week, but its growing balance sheet is concerning
Fed Chair Jerome Powell said just about everything right at his Q&A following last week's FOMC meeting. The Fed upgraded its US GDP expectations for the year from 4.2% to 6.5%; inflation may well go above 2% in the short-term, but that was OK; and the central bank would continue buying bonds at a clip of $120 billion per month. The markets may have cheered the news, but the rising debt load of the Fed, which is part of the nation's $28 trillion overall debt load, is concerning. Before the 2008 financial crisis, the Fed's balance sheet was below $1 trillion. It more than doubled due to the crisis, then plateaued around $2.8 trillion before mushrooming again in 2013 and 2014. Steady at about $4.5 trillion for several years, it did something few would expect: it began falling—all the way back down to $3.6 trillion in September of 2019. Of course, we know what hit the world six months later, causing the balance sheet to more than double. Just shy of $8 trillion now, we can expect (based on Powell's comments) that it will hit $9 trillion before any talk of tapering. Of major note at the FOMC meeting was the fact that only four members saw rates rising in 2022 and another eight (of the eighteen) saw rates coming off of zero in 2023. That is remarkable, at least until we consider that every tick up in rates makes servicing our $28 trillion national debt all the costlier. At least we are not alone in the boat; governments around the world are awash in debt, with few showing signs of hiking rates. In the meantime, let the party continue.
For the first time in a year, the pandemic is not the market's biggest concern—and that is wonderful news. Right now, investors have turned their attention to inflation and Treasury rates creeping up. Our biggest concern right now is none of the above. We see valuations reaching crazy levels on some high-flying tech names which won't turn a profit for years. There will be a tech reckoning at some point this year, which is one reason we have been maneuvering toward a value tilt. Also, portfolios simply got overweighted in growth names due to the run-up. This spring is certainly a good time for a portfolio tune-up.
Auto Parts
03. Goodyear to buy Cooper Tire & Rubber Company for $2.8 billion
There aren't many tire manufacturers based in the United States these days, so the two biggest might as well join forces. Goodyear Tire & Rubber Company (GT $17) has announced its plans to acquire smaller US rival Cooper Tire (CTB) for $2.8 billion in cash and stock. Goodyear, which trails only France's Michelin and Japan's Bridgestone by sales, will suddenly have a much larger global footprint: 50 factories and 72,000 employees around the world, and sales volume of 64 million replacement tires in the US. With demand for replacement tires expected to grow rapidly in the coming years, the move should allow the new entity to grow market share substantially in both the US and China—the industry's two largest markets. Both companies are based out of Ohio.
Obviously, the commodity price of rubber plays a major role in a tire manufacturer's bottom line. Fortunately, global rubber prices have dropped precipitously over the past decade. We would put a fair value on the price of Goodyear shares, post-merger, at $20.
Business & Professional Services
02. Will GoPuff be the poster child for the coming post-pandemic market reality check?
For anyone not familiar with SoftBank, it is the Masayoshi Son-run business that tried to bring WeWork public with founder and walking nightmare Adam Neumann still at the helm (at least originally). For anyone not familiar with GoPuff, it is yet another delivery service which brings products from the store to your home. The latter is being financially backed, in good measure, by the former. Why, you might ask, does America need another delivery service with established competitors such as Amazon, DoorDash, Uber Eats, GrubHub, Walmart, Drizly, Instacart, and an army of grocery stores which are getting into the game? We wish we had the answer. As for their unique value proposition (UVP), the delivery service brings household items such as OTC medicines, snacks, and household essentials to your doorstep. In essence, you are saved that pesky trip to Walgreens. (Actually, don't some of these competitors already do that?)
Forget the viability—or lack thereof—of the company's UVP; we are more concerned about the valuation. In October of 2020, the company raised funds which valued the enterprise at just under $4 billion. Now, fueled with a new round of funding, it is valued at just shy of $9 billion. Keep this in mind as well: GoPuff will probably go public this year, and we have all seen what happens to these novelty (our word) startups out of the gate—many see their shares double or even triple before the dust settles. So, we have a company that may be worth $4 billion (doubt it), it is now valued at $9 billion, and it may be at $20 billion after the IPO. Does that make sense? We love DoorDash, but how many DASH investors even realize that the firm, which has never turned a profit, has a $44 billion market cap as of this writing? There is a house of cards being built, and every house of cards eventually comes crashing down.
Forget the hype being pushed by the old media or on social media with respect to these companies. Do the research, figure out whether they actually do have a UVP, take a look at the numbers, consider the management team in place, and make wise investment decisions based on the easily-accessible research available to virtually everyone. Maybe it is FOMO, or maybe we are simply going stir-crazy in our homes, but there is a whole lot of gambling going on within the markets right now.
Under the Radar Investment
01. Adaptive Biotechnologies Corp
Adaptive Biotechnology Corp (ADPT $42) is a $6 billion biotech firm working in the field of what they refer to as Immune Medicine. By harnessing the power of the adaptive immune system, a subsystem which contains processes that eliminate pathogens or prevent their growth, the company believes it can transform the diagnosis and treatment of disease. The company's clinical diagnostic product, clonoSEQ, is an FDA-authorized test for the detection and monitoring of minimal residual disease in patients with blood cancers. The cornerstone of Adaptive's Immune Medicine platform, immunoSEQ, serves as its underlying R&D engine and generates revenue from academic and biopharmaceutical customers. Shares have dropped from their $71.25 high reached on 25 Jan 2021.
Answer
Space Invaders, created in 1978 by Tomohiro Nishikado, was licensed in the US by the Midway division of Bally. By 1982, the game had grossed nearly $4 billion, making it both the best-selling and highest-grossing (adjusted for inflation) video game of all time.
Headlines for the Week of 21 Feb—27 Feb 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The three worst months...
Going back to 1950, only three months of the year have averaged negative returns for the S&P 500. What are they, and which month is historically the worst?
Penn Trading Desk:
Penn: Open a "new energy" ETF in the New Frontier Fund
We are extremely bullish on the future of renewable energy, especially as it is virtually being mandated by governments around the world. It is a tricky area for investors to navigate, which is why we just added a new ETF to the Penn New Frontier Fund that invests equally in all five areas of this dynamic field: e-mobility, energy storage, performance materials, energy distribution, and energy generation. To see the specific action, Members can log into the Penn Trading Desk.
America is (finally) attempting a comeback in the rare earth arena; we opened a position in the company at the center of the battle
We have discussed, ad nauseam, how America willingly turned over the role of dominant rare earth miner to China, despite the national security risk of doing so. Now, one company plans to restore order in this critical corner of the market, and we have added that company to the Intrepid Trading Platform. Members, see the Penn Trading Desk.
Penn: Open Mid-Cap Gold and Silver Miner in Penn Global Leaders Club
We remain bullish on gold going forward, especially considering the world's perpetually-running currency printing presses. We are very bullish on silver for more industrial reasons. With that in mind, we acquired a Canadian mid-cap gold and silver miner with 30 million ounces of proven/probable gold reserves, and 60 million ounces of proven/probable silver reserves. Our first target price is 53% above the company's current price. Members, see the Penn Trading Desk.
Penn: Closed Aphria in Intrepid after massive run-up
We purchased Canadian pot stock Aphria for $4.63 on 13 Aug 2020 in large part because Irwin Simon took over as CEO. While we expected a longer hold time, the massive run-up in price couldn’t be ignored. We took our 440%, short-term gain, stopping out at $25 per share.
Wedbush: Raise price target on Microsoft
Analysts at Wedbush have raised their price target on Microsoft (MSFT $243) from $285 to $300, maintaining their Outperform rating. They argue that the tide is shifting in the cloud arms race—away from Amazon (AMZN) Web Services and towards Microsoft. We agree.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Transportation Infrastructure
10. Uber jumps on news it is buying booze delivery company Drizly
Approximately 22% of ride-sharing platform Uber's (UBER $57) revenue emanates from food and drink delivery, with its Uber Eats division lagging well behind the likes of DoorDash, Postmates, and Grubhub. The company is making an aggressive move to change that with its $1.1 billion purchase of Drizly, a services firm which currently offers beer, wine, and hard liquor deliveries in over 1,400 cities. The deal will be funded with a mix of Uber stock (90%) and cash (10%), and is expected to close in the first of of this year. While Uber will maintain a separate Drizly app for customers, it will integrate the Drizly marketplace into its existing Uber Eats app. Uber shares were up 7% on the day of the announcement.
This was a smart move, and we continue to see Uber as the dominant player in the industry. That being said, the company lost $7 billion on $12.8 billion in revenues over the trailing twelve months, with the pandemic doing immense harm to its business model. We see UBER shares fairly priced around $60, just $3 above where they currently sit.
Biotechnology
09. Jazz Pharmaceuticals PLC to acquire medical cannabis company GW Pharma for $7B
Jazz Pharmaceuticals (JAZZ $150) is an $8 billion biotech focused in the neurosciences, including sleep disorders, and oncology, including hematologic and solid tumors. The company has a solid and growing revenue stream, and positive net income going back ten years—no small feat for a mid-cap biotech. GW Pharmaceuticals PLC (GWPH $214) is a $6.7 billion biopharma company which develops and markets cannabis-based therapies, such as the first epilepsy drug derived from the marijuana plant. This past week, the Ireland-based Jazz announced it would be acquiring the UK-based GW for approximately $7 billion in a mix of cash, debt, and newly-issued Jazz stock. This is a bold move for the company, considering the deal is worth about 90% of its own market cap and that GW hasn't turned a profit since 2012, but management believes that GW's Epidiolex drug for the treatment of epilepsy will be a billion-dollar blockbuster. Shares of Jazz were trading off about 8% on the news, while the deal sent GW Pharma shares soaring nearly 45% based on the premium paid for the acquisition.
It's a bold bet, but one we like—a lot. The drop in price of JAZZ shares makes the stock even more attractive. In a crazy market where investors are bidding up to buy companies which have never turned a profit, here is a company with explosive potential that has operated in the black for a decade.
Behavioral Finance
08. Sticking it to the man? Koss family cashes in as Reddit army targets the shorts
Readers may be vaguely familiar with the name Koss, but certainly not to the same extent as Bose, Beats, or Sony. To say the Wisconsin-based headphone maker was struggling is an understatement. In fact, going into this year the company was worth about $20 million—the most micro of micro-caps. Then the Reddit army discovered how many short sellers were betting on the company to fail, and sprang into action. Despite minuscule sales and a dearth of profits, they jacked the shares up from around $3 in early January to an intra-day high exceeding $120 per share on the 28th of the month. Corporate executives and the Koss family, which together control 75% of the shares, also sprang into action: they sold $44 million worth of shares of a company that had a market cap of $20 million going into the year. Who can blame them? When you know your company is worth about $3 per share and a group of retail investors suddenly make it worth 40 times that amount, why not rake in the dough? SEC filings show these insiders sold between approximately $20 and $60 per share. Among the family, president and CEO Michael Koss sold around $13 million worth of stock, while John Koss Jr., vice president of sales, sold almost exactly the same amount. The company had a short interest of around 35% before the madness began, putting it on the Reddit army's radar. Shares have since fallen back to $20, only about four times what we value them being worth.
Who knows, maybe the insiders sold the shares to raise cash for a new strategic push, though we doubt it. In the meantime, we would like to meet the "investors" who bought into a company with horrendous fundamentals while the share price was between $100 and $120. We would like to simply ask them "why?"
Cryptocurrencies
07. Tesla shifts $1.5 billion of its cash reserve to Bitcoin, will accept the crypto as a payment source soon
Going into the new year, $800 billion EV juggernaut Tesla (TSLA $854) had about $19 billion sitting in cash reserves. In a move that GM or Ford would never consider making, the firm revealed—via an SEC filing—that it has placed about $1.5 billion of that amount, or roughly 8%, in the cryptocurrency Bitcoin. Let there be no doubt, Bitcoin is not a currency; rather, it is a commodity. Forget the compari
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The three worst months...
Going back to 1950, only three months of the year have averaged negative returns for the S&P 500. What are they, and which month is historically the worst?
Penn Trading Desk:
Penn: Open a "new energy" ETF in the New Frontier Fund
We are extremely bullish on the future of renewable energy, especially as it is virtually being mandated by governments around the world. It is a tricky area for investors to navigate, which is why we just added a new ETF to the Penn New Frontier Fund that invests equally in all five areas of this dynamic field: e-mobility, energy storage, performance materials, energy distribution, and energy generation. To see the specific action, Members can log into the Penn Trading Desk.
America is (finally) attempting a comeback in the rare earth arena; we opened a position in the company at the center of the battle
We have discussed, ad nauseam, how America willingly turned over the role of dominant rare earth miner to China, despite the national security risk of doing so. Now, one company plans to restore order in this critical corner of the market, and we have added that company to the Intrepid Trading Platform. Members, see the Penn Trading Desk.
Penn: Open Mid-Cap Gold and Silver Miner in Penn Global Leaders Club
We remain bullish on gold going forward, especially considering the world's perpetually-running currency printing presses. We are very bullish on silver for more industrial reasons. With that in mind, we acquired a Canadian mid-cap gold and silver miner with 30 million ounces of proven/probable gold reserves, and 60 million ounces of proven/probable silver reserves. Our first target price is 53% above the company's current price. Members, see the Penn Trading Desk.
Penn: Closed Aphria in Intrepid after massive run-up
We purchased Canadian pot stock Aphria for $4.63 on 13 Aug 2020 in large part because Irwin Simon took over as CEO. While we expected a longer hold time, the massive run-up in price couldn’t be ignored. We took our 440%, short-term gain, stopping out at $25 per share.
Wedbush: Raise price target on Microsoft
Analysts at Wedbush have raised their price target on Microsoft (MSFT $243) from $285 to $300, maintaining their Outperform rating. They argue that the tide is shifting in the cloud arms race—away from Amazon (AMZN) Web Services and towards Microsoft. We agree.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Transportation Infrastructure
10. Uber jumps on news it is buying booze delivery company Drizly
Approximately 22% of ride-sharing platform Uber's (UBER $57) revenue emanates from food and drink delivery, with its Uber Eats division lagging well behind the likes of DoorDash, Postmates, and Grubhub. The company is making an aggressive move to change that with its $1.1 billion purchase of Drizly, a services firm which currently offers beer, wine, and hard liquor deliveries in over 1,400 cities. The deal will be funded with a mix of Uber stock (90%) and cash (10%), and is expected to close in the first of of this year. While Uber will maintain a separate Drizly app for customers, it will integrate the Drizly marketplace into its existing Uber Eats app. Uber shares were up 7% on the day of the announcement.
This was a smart move, and we continue to see Uber as the dominant player in the industry. That being said, the company lost $7 billion on $12.8 billion in revenues over the trailing twelve months, with the pandemic doing immense harm to its business model. We see UBER shares fairly priced around $60, just $3 above where they currently sit.
Biotechnology
09. Jazz Pharmaceuticals PLC to acquire medical cannabis company GW Pharma for $7B
Jazz Pharmaceuticals (JAZZ $150) is an $8 billion biotech focused in the neurosciences, including sleep disorders, and oncology, including hematologic and solid tumors. The company has a solid and growing revenue stream, and positive net income going back ten years—no small feat for a mid-cap biotech. GW Pharmaceuticals PLC (GWPH $214) is a $6.7 billion biopharma company which develops and markets cannabis-based therapies, such as the first epilepsy drug derived from the marijuana plant. This past week, the Ireland-based Jazz announced it would be acquiring the UK-based GW for approximately $7 billion in a mix of cash, debt, and newly-issued Jazz stock. This is a bold move for the company, considering the deal is worth about 90% of its own market cap and that GW hasn't turned a profit since 2012, but management believes that GW's Epidiolex drug for the treatment of epilepsy will be a billion-dollar blockbuster. Shares of Jazz were trading off about 8% on the news, while the deal sent GW Pharma shares soaring nearly 45% based on the premium paid for the acquisition.
It's a bold bet, but one we like—a lot. The drop in price of JAZZ shares makes the stock even more attractive. In a crazy market where investors are bidding up to buy companies which have never turned a profit, here is a company with explosive potential that has operated in the black for a decade.
Behavioral Finance
08. Sticking it to the man? Koss family cashes in as Reddit army targets the shorts
Readers may be vaguely familiar with the name Koss, but certainly not to the same extent as Bose, Beats, or Sony. To say the Wisconsin-based headphone maker was struggling is an understatement. In fact, going into this year the company was worth about $20 million—the most micro of micro-caps. Then the Reddit army discovered how many short sellers were betting on the company to fail, and sprang into action. Despite minuscule sales and a dearth of profits, they jacked the shares up from around $3 in early January to an intra-day high exceeding $120 per share on the 28th of the month. Corporate executives and the Koss family, which together control 75% of the shares, also sprang into action: they sold $44 million worth of shares of a company that had a market cap of $20 million going into the year. Who can blame them? When you know your company is worth about $3 per share and a group of retail investors suddenly make it worth 40 times that amount, why not rake in the dough? SEC filings show these insiders sold between approximately $20 and $60 per share. Among the family, president and CEO Michael Koss sold around $13 million worth of stock, while John Koss Jr., vice president of sales, sold almost exactly the same amount. The company had a short interest of around 35% before the madness began, putting it on the Reddit army's radar. Shares have since fallen back to $20, only about four times what we value them being worth.
Who knows, maybe the insiders sold the shares to raise cash for a new strategic push, though we doubt it. In the meantime, we would like to meet the "investors" who bought into a company with horrendous fundamentals while the share price was between $100 and $120. We would like to simply ask them "why?"
Cryptocurrencies
07. Tesla shifts $1.5 billion of its cash reserve to Bitcoin, will accept the crypto as a payment source soon
Going into the new year, $800 billion EV juggernaut Tesla (TSLA $854) had about $19 billion sitting in cash reserves. In a move that GM or Ford would never consider making, the firm revealed—via an SEC filing—that it has placed about $1.5 billion of that amount, or roughly 8%, in the cryptocurrency Bitcoin. Let there be no doubt, Bitcoin is not a currency; rather, it is a commodity. Forget the compari