What We’re Watching Next Week, Including Wells Fargo Profits

Wells Fargo signage on May 5, 2021 in New York City.

Bill Tompkins | Michael Ochs Archives | Getty Images

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The markets had a shaky start to the new year. As the major indices posted weekly losses, the economically-sensitive Dow Jones Industrial Average was the relative outperformer, with investors positioning themselves for a year in which the Federal Reserve is expected to hike rates and cut the rate. size of its balance sheet. In line with increased attention to rate hikes, the highly technical Nasdaq Composite was relatively lagging, now over 7% of the all-time high reached in November.

At the end of the day, we’re not that surprised by the stock and think it’s consistent with our view that in 2022 you want to own the stocks of companies that ‘do things and make things’. while avoiding “story stocks,” that is, high-flying, longer-lasting concept names with little or no earning potential.

Remember, stocks are valued based on future earnings and cash flow. We generate a present value for businesses by estimating these numbers over the past year and then discounting them to the present day using a discounted cash flow (DCF) model. When rates are virtually zero, the discount rate (the denominator in a DCF model) is minimal and therefore investors can speculate and look to the future as far as they want, as future value is essentially the same. like today. But when rates rise, the discount rate (or the rate of return that investors demand for the risk they take by owning stocks) must rise. This increased denominator means that the present value of future earnings and cash flow decreases. The farther away these gains are, the less they are worth today, with each tick increasing rates.

An example of the impact of rising rates on valuations:

To better illustrate this, consider an example of the impact of a higher discount rate on future profits.

Company A is a high-flying tech action (think of something in the EV space that went public through PSPC or an enterprise software company) with a promise for the future but no profit power today, which makes it a longer lasting asset in the context of equities. Company B is a cyclical name of value, such as a large cap financial or industrial company. These companies are traditionally viewed as short-lived assets.

Company A is expected to generate $ 10 per share in earnings in 2027 (five years from now), while Company B is expected to generate $ 10 per share by the end of 2022. A rate hike means Company A’s profits are discounted to present five full years at a now higher rate, while company B only needs to be discounted for one year at that higher rate.

When rates are on the rise, the impact of discounting to the present day has an increasing effect the more you have to do it. This causes investors to look for shorter-lived assets like Company B rather than stocks like Company A. Ultimately, A and B will both generate $ 10 in profit. However, the present value of Company B’s $ 10 profit is worth more and more compared to that of Company A as rates rise.

That is why we want to own the shares of companies that are generating real profits today. The closer these profits are to today, the less impact the rate hike has on their current values, making those incomes more attractive compared to those of frequent travelers who see their current intrinsic values ​​fall on higher rates. students.

Here’s a quick look at some of the broader market metrics we like to keep an eye out for: The US dollar index fell slightly but remains just below the 96 level. Gold was roughly flat over the week , trading around the $ 1,800 level. WTI crude prices strengthened to the top $ 70 per barrel region. And the yield on the 10-year Treasury bill had a good week in response to hawkish minutes from the Fed and falling unemployment rates. The 10-year yield is now around 1.77%, the highest levels since January 2020.

No portfolio company reported this week.

In addition to the results, we received several key macroeconomic updates:

Monday

Tuesday

ISM Manufacturing: 58.7% versus 60.0% estimate

Wednesday

ADP survey on employment: 807,000 against 375,000 estimate

Thusday

-Initial unemployment claims: +207,000 against +195,000 estimate
-Moving average over four weeks: 204,500 (+4,750 compared to the previous week)
-Factory orders: + 1.6% MoM against 1.5% MoM estimate
– Basic capital equipment orders: unchanged MoM
-ISM services: 62.0% vs 67.0% estimate

What we are monitoring to come:

The earnings season kicks off next week as the banks are about to report. Within the portfolio, we’ll hear Wells Fargo (WFC) on Friday, before the opening bell. Other reports we will be monitoring include:

Monday

Open: AZZ (AZZ), Commercial Metals (CMC), Tilray (TLRY)
Close: Accolade (ACCD)

Tuesday

Open: Albertsons (ACI), TD Synnex (SNX)
Close:

Wednesday

Open: Jefferies (JEF), Shaw Comms (SJR)
Close: KB Home (KBH)

Thusday

Open: Delta (DAL), Taiwan Semi (TSM)
Close:

Friday

Open: BlackRock (BLK), Citigroup (C), First Republic Bank (FRC), JPMorgan Chase (JPM)
Close:

On the macroeconomic level, in addition to keeping an eye on the geopolitical sphere as well as for the following releases (all weather ET):

MONDAY

10:00 SA Wholesale Inventories M / M (Final)

TUESDAY

06:00 NFIB Small Business Index

WEDNESDAY

08:30 am Consumer Price Index (CPI)
08:30 Hourly wage SA M / M (Final)
08:30 Hourly earnings Y / Y (Final)
08:30 am Average SA work week (final)
2:00 p.m. NSA Treasury Budget

THURSDAY

08:30 Continuous unemployment claims SA
08:30 am Initial complaints SA
8:30 a.m. Product Price Index (PPI)

FRIDAY

08:30 NSA H / M Export Price Index
08:30 NSA Import Price Index H / M
8:30 am Retail sales
9:15 am Use of NSA capacity
09:15 Production Industrielle SA H / H
09:15 Manufacturing Production H / H
10:00 Inventories of SA companies M / M
10:00 Michigan Sentiment NSA (Preliminary)

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(Jim Cramer’s charitable trust is long WFC.)


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