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.
New Dungeness Light Station, Sequim, Washington
This lighthouse is located in Washington state and is a functioning aid to navigation on the Strait of Juan de Fuca. The lighthouse was opened in 1857, and is open to tourists.
Big Bay Point Light Station, Big Bay, Michigan
This lighthouse was opened in 1896 and stands at 20 meters tall. It is located on the Upper Peninsula of Michigan. The lighthouse is one of a few operational lighthouses with a bed and breakfast.
*Feel free to send us your photos of Lighthouses to be featured in our weekly market observations. *
Cash cows
Crescat Capital published an interesting chart in a recent commentary they posted. The chart caught our eyes and continues to confirm some of our thoughts on 2 areas of the market. Energy and precious metal producers have the highest cash flow margins across U.S. equity markets. These companies are seriously printing cash.
Cash flows are a major reason many deep-value investors have rotated into the precious metal and energy sectors in recent years. Both sectors were beaten down to a pulp for over a decade and were forced to restructure, clean up their balance sheets, and focus on returning capital to shareholders. Fast forward to today and quality companies especially in energy are doing this. It’s a reason Buffett and Berkshire Hathaway have been buying various U.S.-based oil producers, and why gold mining companies are some of the strongest performers this year. Margins are up, and cash flows are strong. With gold trading at an all-time high, miners are printing cash. These companies are still relatively cheap and over the next few quarters, we think they will be huge outperformers.
Chinese structural weakness
Barclays downgraded some retail stock this week after analysts visited China and noted a real slowdown, especially in retail.
The analysts went to malls, shopping centers, and stores across the country and saw weaker sentiment than they saw at the start of this year. They noted that the Chinese weakness looked structural.
The two analysts noted that the high growth phase of the Chinese economy is over, and the finance and property sectors are still under pressure. Many have turned cautious in these areas due to the crisis in real estate as investors no longer see the sector as a cash cow in China, as the bubble has completely burst (in Chinese real estate).
There is also evidence of the private sector shrinking and state-owned companies growing in recent years. We think this rotation is the CCP (Chinese Communist Party) trying to gain more control of the country and is a last-ditch effort to try and solve the issues the Chinese economy has faced.
The slowdown in the retail sector in China led Barclays to cut their 2025 growth expectations for the luxury retail industry to 4% from 7%. Barclays downgraded Burberry, Kering, Adidas, Gucci, and other retail stocks on Monday morning after this trip.
We are not bringing this up because we have exposure to those companies. We bring it up because Barclays is giving us an inside view into what’s happening in the world’s second-biggest economy. Barclays confirmed what we have thought for a few years now, China’s growth is slowing, their economy is becoming more state-run, and many of their companies are not investable to us as an asset manager.
We will continue to highlight China despite having no direct exposure to the country as it will lead to divestment from companies in China and impact the sales and profitability of companies who heavily rely on the Chinese market. Nearshoring is real, and the great corporate rotation from China is well underway.
On the luxury front, we are glad we have no exposure. Louis Vuitton shares are down 15% this year, Christian Dior shares are down 16% this year, Kering (parent of Gucci, Balenciaga, and other luxury brands) shares are down 42% this year, and numerous other luxury brands are trading near yearly lows.
After these beat downs, perhaps some in depth research is require to see if there is any value moving forward.
Silver demand surging
The demand for silver continues to surge. This demand growth is being driven by the likes of solar power, and artificial intelligence.
In 2023, the silver market experienced a 15% supply deficit; the market is expected to remain in deficit for the foreseeable future.
These deficits will persist until new mines are established and invested in. However, many mining companies are hesitant to invest in mass expansion due to risk.
According to Sprott, silver is the second most widely used commodity, with more than 10,000 applications. The metal is a key component in both solar panels and electric vehicles. In addition, the metal is used in semiconductors, controls, sensors, and LIDAR technology in AI enabled transport. Phones also utilize silver as do numerous applications in the healthcare world.
Despite the rising demand for silver, reserves have rapidly declined. The industry faces a lack of investment in primary silver mines. Approximately 70% of silver mined last year was a byproduct of gold, copper, or other mining.
If the market continues to see demand growth, new mines will be necessary to supply this growth. We think these market dynamics will eventually lead to much higher silver prices. Silver has lagged gold’s price performance recently and we think it’s due for a catch-up due to the growing demand for the metal and underinvestment in silver mines. Do not be surprised to see boring old silver go on a run of its own.
Palantir shares pop to open the week
Palantir Technologies, a company that specializes in software platforms for big data analytics founded by tech legend, Peter Thiel, popped on Monday after it was announced Palantir would be joining the S&P 500 over the weekend. Shares jumped by 14% and are trading at a 52-week high. Shares are up 108% in 2024 and are up 276% since its IPO in 2020.
Palantir is being joined by Dell in the additions to the S&P 500. They will replace Etsy and American Airlines. Dell shares rose by 4% after the announcement.
Companies who are added to major indices often see rallies as fund managers who track indices update their portfolios to mimic the specific index.
To be listed on the S&P 500, a company must have reported a profit in its latest quarter and have a cumulative profit over its latest 4 quarters. Palantir reported a profit of $136 million in Q2 and has been profitable every quarter since Q4 2022. However, the company trades extremely expensively, and its price-to-earnings ratio exceeds 200x.
This further skews the S&P 500 toward the technology sector. In June, the S&P 500 added CrowdStrike, and GoDaddy, both of which operate in the technology sector.
Most volatile mega cap ever
Nvidia continues to cement itself as a critical stock to overall equity markets. Its earnings reports seem to be something all market participants follow. The stock despite its strong performance is fuelled by massive moves, something that we think is being fuelled by overreactions from investors and a lack of patience.
Here is a chart from Charlie Bilelo that highlights the largest daily gains and losses in terms of market capitalization in history. Do you notice almost all these moves are Nvidia (to the upside and downside)?
Most of these massive moves in market capitalization have occurred this year as investors become even more impatient, uncertain, and bullish on AI.
We understand that these huge moves are only possible today (or over the last few years) due to their pure size. However, we think Nvidia is the leader on the chart above due to its meteoric rise, and investors going all in on AI. Investors have ignored fundamentals and valuation when it comes to Nvidia.
Shares are now off 25% from their all-time high as investors seem to have realized that valuation matters and Nvidia’s growth will more than likely slow. This further confirms the most expensive stocks often perform the poorest during times of market uncertainty, and increased volatility. We would rather own quality rather than hype in the market environment we see today.
Military aid monopoly
We understand that the U.S. is the leader of the free world and that our neighbors to the south are the most powerful countries in the world. This title has led them to enter numerous wars across the world over the last few decades. Even when they do not send troops, they send a huge number of resources. The resources they send across the world do not compare to the resources sent by their allies. When looking at the most recent conflict in Ukraine, the U.S. has sent almost double the financial, humanitarian, and military aid to Ukraine than the European Union.
On a conflict front, the U.S. does not force its allies to support their conflict efforts at the same levels. It seems this level of commitment for the U.S. is unsustainable and the U.S. should be requiring its Western allies to foot their fair share of the bill.
We understand the U.S. has a larger population than all the countries listed above and other allies of theirs like Australia, Japan, and South Korea so U.S. aid will always be greater. The data point that we do not understand is the European Union whose population is over 100 million larger than the U.S.’s population.
We hope the vast spending by the U.S. government on these recent conflicts is noticed by the American population and the American people force the government to answer for these data points.
Tough corporate times
U.S. bankruptcies year to date hit 452. The second highest count for the first 8 months of a year since 2010. The only year higher was 2020, we all know what happened that year. Companies are feeling the same pain consumers are feeling and are filing for Chapter 11 at an alarming rate. This is why owning quality always matters.
Bankruptcy filings jumped month over month in August as certain corporate balance sheets continue to worry investors.
Click here for the PDF: The Weekly Beacon – September 13 2024
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MacNicol & Associates Asset Management                                                            Â
September 13, 2024
