The US economy is still running hot. The third quarter brought more of the same volatility seen throughout the year. The markets are adapting to The Fed’s medicine: higher interest rates to slow the economy. On September 21st, The Federal Reserve bank increased the federal funds rate by another 75bps. This was widely anticipated. However, in his comments, Fed Chairman Powell emphasized that their number one focus is fighting inflation. Until this point, markets had been reluctant to take him at his word with many expecting that he might soon pause or reverse. Now, the message is clear, the Fed will do “whatever it takes” to beat inflation.
“The ability to distinguish between volatility and loss is the first casualty of a bear market.” – Nick Murray, Author of Simple Wealth, Inevitable Wealth
US Stocks officially entered a bear market on June 13th when the S&P 500 closed 22% below its January 3rd high. We’ve been here before. Only two years ago, Covid-19 caused a panic in equity markets which led to a more than 30% market decline. Those losses were (relatively) quickly reversed as investors realized that both Congress and the Federal Reserve were quickly acting in their favor. Easy monetary policy supported what we can now clearly see, in hindsight, was a speculative market bubble that continued for another two years.
“Most of the time, the end of the world does not happen. “ — Howard Marks, Co-Founder of Oaktree Capital Management
As we close the first quarter of 2022, all signs point to our economy moving into a new stage of the business cycle. We are past the peak and rolling into the earliest stages of contraction. After laying the groundwork for months, the Federal Reserve Bank officially began raising interest rates earlier this year. Their goal is to dampen inflation which has now increased to alarming levels and is affecting businesses and families across the socioeconomic spectrum. The Fed has most likely taken too long to act, and they are removing stimulus that was too excessive and lasted for too long. While the Fed’s quick action likely saved our economy from the worst possible outcomes during the pandemic, we are now surrounded by inflation that is having real world impact.
Company: SolarEdge Technologies Inc
Sector: Technology – Solar/Alternative Energy
Price/Market Cap: $245/$13.1B
I first encountered SolarEdge in mid-2019 while reviewing a non-Wall Street report on the solar industry ecosystem. I was reading the report purely out of curiosity. It was only after digging in that I realized there might be some decent investment ideas within the sector. I was not interested in solar panel manufacturers that would be heavily reliant on imported raw materials and subject to fluctuating commodity prices. The installers are services businesses, characterized as cyclicals with high operating costs and scalability headwinds. Cabling is commoditized. But when I read the section about power optimizers and inverters, I had an “Aha!” moment –These are the proverbial “picks and shovels” within the renewable industry. These devices are built using semiconductor technology that I am highly familiar with, and these systems are essentially the “brains” of the solar panels built with technology that can likely be applied to numerous other form factors in and out of the sector. Opportunity.
Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair. -Sam Ewing (author)
We ended 2021 similar to how we began, challenged by Covid as the virus continues to alter holiday plans, disrupt commerce and frustrate a world weary of the conversation. Covid was supposed to be conquered by this point, but virus mutations and vaccine hesitancy have allowed this visitor to remain with us. What is different this time around is the Omicron variant appears to be more prevalent, but less deadly. Hospitalization risk appears to be 1/3 that of the Delta variant but, given that Omicron is more infectious and has a shorter incubation period, hospitalizations are going up. We began 2022 with an all-time high of 1 million active new U.S. cases.
“When all the experts and forecasts agree – something else is going to happen.”
– Bob Farrell, Wall Street Market Strategist
September and October have brought cooler weather and, along with it, volatility to the markets. Neither are unexpected. Season are seasons, and September has historically been the weakest month of the year for stocks. The S&P 500 ended September with a 4.8% decline which was only the second down month for 2021. October is also considered to be a volatile month for investors. The 1929 “Black Tuesday” stock market crash occurred on October 29, 1929. The “Black Monday” Crash of 1987 took place on October 19, 1987. And while the fall of Lehman Brothers technically started when the company filed for bankruptcy on September 15, 2008, October 2008 experienced major market declines as we steamrolled our way into the financial crisis. Even as recently as 2018, U.S. markets lost $2T in October.
The S&P 500 is up 14.4% for the first half of 2021. Much of these gains were triggered by companies announcing positive earnings expectations for the second half of the year. A record 64% of companies that provided guidance exceeded Wall Street Analyst projections. Most companies have positioned the pandemic in the rear-view mirror and expect things to get better from here. Meanwhile, the Market continues to hit all-time highs, while Wall Street seems to be overly conservative on future prospects. The source of caution stems from expected inflation.
Company: Whole Earth Brands (FREE)
Sector: Consumer Staples – Packaged Foods
Price/Market Cap: $13.40/$500M
Target Price/Implied Upside: $25.00/85%
Undervalued, consumer packaged goods company engaged in consolidating the “Better for you” sweetener market. Led by industry veterans, Whole Earth’s strategy is supported by strong brands, global tailwinds, and a long-established customer base. The business leverages an asset lite model ideal for scaling newly acquired brands.
“Faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.“ – John Kenneth Galbraith
We continue to experience a K-shaped recovery. Many of us (and most likely those reading this post) live in a way that limits insight to the challenges that many still face. A narrow segment of the population is flush with cash having had limited spending outlets over the past year. As vaccine roll out becomes more widespread and faster, mask mandates begin to be lifted. Consequently, local economies open and an accelerated return to normalcy takes place filled with individuals eager to repeat the “Roaring 20s.” Conversely, another segment of the population is having an entirely different experience that isn’t part of the “roaring re-opening” narrative.
“Bull markets end when the perception of earnings growth disappears […]. Manias, on the other hand, end when the market runs out of buyers.” – Andy Kessler
2020 ended with the world collectively eager to put a challenging year in the rear-view mirror while looking forward to the light at the end of the tunnel. The US election results are now (mostly) behind us, and we have two approved Covid-19 vaccines being distributed in the US with an additional 5 being used in other parts of the world. What is most surprising to me is, having witnessed a year where we endured the worst global pandemic in a century, the fastest bear market in history, a global recession, and a contentious presidential election; that I would find myself in the same place I was exactly a year ago: contemplating whether the market accurately reflects the reality of our economy.