BEACONS OF THE WEEK
The two main purposes of a Lighthouse are to serve as a navigational aid and to warn ships (Investors) of dangerous areas. It is like a traffic sign on the sea.
Cape Byron Light, Byron Shire, New South Wales, Australia
This lighthouse is an active heritage listed lighthouse and now maritime museum, and tourist attraction. The lighthouse was constructed in 1901. The lighthouse stands at 74 feet tall and was designated as a Heritage building on the Commonwealth list in 2004.
Fingal Head Light, Fingal Head, New South Wales, Australia
This lighthouse is an active lighthouse constructed in 1872 and automated in 1920. The 23-foot lighthouse is managed by the New South Wales Department of Lands. There is a picnic and beach area just north of the lighthouse for tourists to visit the area but the lighthouse is closed to the public.
The books never lie
What’s this? Mid-day on Tuesday, there was a sharp downturn in the odds that President Biden would be the nominee on the Democrat ticket in November’s election.
The odds for Biden tanked from 90% down to 50% according to multiple users on X.
Betting sites usually front-run consumers so we must take this move seriously. This move comes a week after Biden’s poor performance at the Presidential debate last week which has fueled numerous calls for him to step down from his side of the aisle.
Will he step down? As of now, it looks like no.
But we will continue to stay on top of this especially as we head closer to the election.
For now, it looks like we could all have a summer surprise and see somebody else face off against former President Trump.
On Wednesday Biden’s odds to be the Democrat nominee for President in 2024 tanked even more as he reportedly weighed remaining in the race with his inner circle. At the same time, VP Kamala Harris’s odds surged.
Buffett indicator screaming
Warren Buffett’s favorite indicator is flashing a signal and you should pay attention. The Wilshire 5000 or Buffett Indicator measures the ratio between the stock markets market capitalization and the Gross Domestic Product of the U.S.
Buffett and many investors utilize the ratio to identify long-term trends across domestic equity markets. It has gained prominence as a long-term valuation indicator for stocks. In 2001, Buffett said the ratio is probably the best single measure of where valuations stand at any given moment.
The ratio is approaching 200% meaning the stock market’s market capitalization is worth nearly 200% of the U.S.’s GDP. The ratio is 1% off its all-time high (data going back to 1970) which was reached in November 2021. In simple terms, the higher the ratio is, the more expensive stocks are.
The ratio sits well above the levels we saw before the Internet bubble burst in the early 2000s.
Is this a sign that equity markets are due for a pullback or a sign of the times? We think a mix of both. Many investors are willing to justify paying 50 times earnings for a tech stock or 15 times book value for a semiconductor stock due to growth potential. For that reason, along with many others, we think the Buffett Indicator will remain elevated relative to historical averages moving forward. However, we still believe valuations matter and that this indicator along with the state of the economy should serve as a warning for many investors especially investors who buy high multiple securities.
Tale of the times?
The Shanghai Container Freight Index continues its move up and trade futures now are hinting to peaks above where they were in 2021 and 2022.
Shipping rates surged during Covid-19 due to increased demand, as well as global travel restrictions. Shipping costs surging were felt by consumers across the world as corporations passed these added expenses onto consumers. These increased freight rates were one of the reasons the world saw a huge upswing in inflation over the last few years. Shipping rates are increasing during this cycle due to Houthi attacks in the Suez Canal.
If rates are moving up yet again, it could foreshadow higher, not lower inflation moving forward. This could impact the moves that global central Banks can make regarding benchmark interest rates.
Another reason we have season-higher freight rates across the globe in recent years is due to the increase in global trade, as well as a lack of new supply in the shipping industry. When you have increased demand for shipping containers, and freight boats due to increased global trade, while the amount of shipping boats, and containers does not increase, higher prices are inevitable.
If you do not believe us, look at the performance of the SonicShares Global Shipping ETF:
*We do not own the ETF ‘BOAT’, we are simply using it as a proxy to drive our point across. We own various stocks across the shipping, dry bulk, and container industries across various client accounts.*
The other very attractive aspect of the shipping industry is the multiples that the securities trade at relative to their historical averages and relative to the rest of the market. Even with their recent run-ups, many of these stocks still trade at bargain valuations that are easy for us to justify.
The shipping industry was beaten down for years. There was an oversupply of container ships which caused numerous bankruptcies, the scrapping of vessels, corporate restructurings, and the cleaning of balance sheets. Fast forward to today, and shipping companies are hesitant to expand their fleet due to issues seen in the industry last cycle. Companies also have a lack of funding due to the net-zero and ESG movements.
We think the fundamental and structural issues that the industry faces have not been addressed which will continue to send freight rates higher as well as shipping stocks. Unless the world suddenly sees a huge downtick in global trade or consumers suddenly are content with shipping times quadrupling, we see prices moving higher.
It might not be sexy like tech or AI or crypto, but it can still make you money. Do not overlook this industry.
How the times have changed
Despite inflation slowing, it has not disappeared. It has also not dropped vertically like many politicians naïvely thought. Investors have been hoping for a decrease in inflation so interest rates can move off their multi-decade highs. However, most Central Banks have so far resisted the temptation to slash rates. Even the countries that have cut rates have done it in a much slower fashion than once forecasted.
We forecasted the higher for a longer thesis over a year ago and have been rewarded for a strong call. At one point, market forecasters predicted rate cuts as soon as the end of 2023 and numerous cuts in 2024, fast forward halfway through 2024 and the FED has yet to cut once, and the Bank of Canada has cut its benchmark rate only once by 25 basis points.
So just how much have expectations changed since the start of this year? Great question. They have changed a lot and Charlie Bilelo was kind enough to show those changes in graphical form.
The image above shows two paths for the FED stemming from FED Funds Futures, one from the start of the year and one from this week. It shows a huge change in the forecast for interest rates. At the start of the year, 6 rate cuts were expected, now futures point to 1-2. Quite the change.
We expect 1 potential cut this year (we are not FED policy or economic experts), unless inflation numbers jump over the next month or two. Beyond that, we think rates will remain higher for longer. 0% borrowing rates are not sustainable, and we do not think we will return to those levels anytime soon. We went through a 40-year cycle where bond investors greatly profited from declining rates, that cycle is over, and we are entering a new cycle across debt markets. Position accordingly.
Tesla shares surge
Tesla shares surged over the last 5 trading sessions by 24% led by strong jumps on Tuesday and Wednesday. The stock bouncing was due to strong delivery numbers which beat Wall Street estimates. Tesla shares have also erased most of their losses this year over the last 6-8 weeks as shares are sitting down 2.7% YTD versus being down 43% YTD at the end of April.
Back to Tesla’s delivery numbers…
On Tuesday, Tesla released its second quarter numbers. The company delivered 443,956 vehicles, 4,000 more than what Wall Street had forecasted. Deliveries in Q2 beat Q1’s figure but trailed last year’s Q2 number by over 20,000 vehicles.
Despite the drop year over year, many analysts covering the EV industry pointed to signs that the industry or Tesla alone is holding up better than expected. The EV industry has struggled in recent quarters due to consumers passing on EV purchases due to their elevated price, and logistical issues. Citi’s EV analyst says sentiment is at a 6-month high for EVs and this data from Tesla further confirms this trend. The analysts went on to say that he will be focused on Tesla’s gross margins in their earnings release later this month.
Elon Musk noted the struggles that EV producers currently face at Tesla’s shareholder meeting last month citing that it has been “tough sledding”.
Gross margins for Tesla will more than likely decrease as the EV producer has slashed prices for its vehicles amid increased global competition.
Tesla was not the only EV producer to report stronger-than-expected Q2 deliveries. On Monday, Chinese peers Li-Auto, Nio, and XPeng all reported big delivery beats as well.
However, some analysts still believe Tesla’s competitive advantage in the short term has disappeared citing that the company will not increase production due to flattening EV adoption across the West and aggressive Chinese competition.
We do not own Tesla shares but continue to watch its shares Whipsaw aggressively as investors cling to every piece of data released that supports their view.
Chinese American relations breakdown
We all know China and the U.S. have had a rocky few years. Trade disputes between the two nations have accelerated and a full-out conflict looks more probable than ever between the two (we do not think there will be one, but the odds have dramatically increased). The world’s two largest economies will more than likely fight through trade or a proxy war.
As this has happened, China has turned to the East and some enemies of the U.S. for support like Russia.
We only bring this up because we ran across a very interesting chart from the Economist this week.
The chart tracks the number of international students from China and India in the U.S. attending universities.
You can see where the U.S. began to treat China like an enemy and where trade disputes began.
The country that has filled the void in terms of trade and international students has been the world’s most populous country, India.
We expect this trend to continue and the decoupling of the West and East to accelerate.
Expect countries like India to greatly benefit from this trend moving forward. India is already the fastest growing major economy on earth and that is expected to continue. Despite its recent growth, there is still a lot more room for growth in India.
There are 1 billion people in India who still do not have air conditioning and more than 150 million people who have no electricity. The country and its government continue to expand its grid and energy capabilities predominantly through fossil fuels. Recently, the government even asked power companies to order equipment worth $33 billion this year to fast-track capacity additions of coal-fired power in the years ahead. This request was made to booming electricity demand that is reportedly not being met.
Tech companies are choosing India in droves for new infrastructure which will require a tremendous amount of grid capacity.
We bring this all up because there is a direct correlation between economic prosperity and energy consumption. We will let you conclude how to position based on this data.
Google’s climate goals fall short
Three years ago, Google set an ambitious goal to address climate change by targeting net zero by 2030. The corporation which is not an energy company piled into the hype of ESG and climate goals.
However, a report released on Tuesday shows the company is nowhere near there 2030 goal. Its emissions have not declined they grew by 13% in 2023 from the year prior and by 48% from its 2019 baseline year.
In the report, Google cited AI and the demand it puts on data centers for its emissions growth. The massive amounts of electricity needed are created by burning coal or natural gas which both emit greenhouse gases.
The company has made one of the most significant commitments in the technology sector regarding net zero and has been seen as a global leader in the fight against climate change.
Google’s Chief Sustainability Officer told the AP that reaching Google’s goal of net zero is an extremely ambitious goal that will not be easy to reach. Perhaps some early warning that the company will not reach its 2030 goal.
Some climate experts say AI power demand will threaten the entire energy transition. AI data centers are also being built where electricity is cheapest, places where renewables do not play a huge role.
Global data center and AI electricity demand is reportedly expected to double by 2026 according to the IEA.
Microsoft has faced similar issues in its emissions growth in recent years.
The only positive for Google’s environmental report released this week is that as their consumption has increased so has the company’s use of renewable power sources.
We believed the climate and ESG bubble of the early 2020s would slowly deflate. We do not think it will disappear, but it will be a much slower process than what many originally believed. Just look at the demand for oil and gas this year across the globe, we continue to reach all-time highs.
Continue to remember that increased AI usage and capabilities equals increased energy demand.
MacNicol & Associates Asset Management
July 5, 2024
