The Weekend Edition #2

Welcome to the second issue of the Weekend Edition. 

Grab a cup of coffee ☕️, and relax while we take a quick look at what happened in the markets this week.

Market Recap: 26 Jul - 30 Jul 2021

Markets were as they say “choppy” this week. With big tech, and big cyclicals putting out earnings reports, controversial companies debuting, Chinese ADRs still remaining volatile, the Fed meeting and to round it off the Covid Delta variant gaining steam. 

That’s a lot for one week! 🤯

While the US indices closed lower on Friday, they still remain on the higher end of the 52-week range. All three major indices had a negative 5-day return.

US10Y rate was at 1.224% on Friday. Goldman Sachs claims with low bond yields where they, or even rising modestly, valuation models imply a further 6% rise in the S&P. The Group is bullish on stocks claiming that the earning yield on the S&P, is still 3.6% above the 10 year bond rate. 

And on Wednesday, the Fed’s decision was to hold rates steady and JPow essentially told reporters on the call after the meeting that they had no intentions of increasing rates anytime soon. Given the amount of US debt and funding needs, it makes sense that the Fed would want to keep rates low. While the Fed Chair did say that Inflation is real and would stay for a few more quarters, he dismissed it as…. yet again “transitory” and that the economy would “pass through” this phase. [more on this below]

So what’s been weighing down on the Markets this week then? ⬇️

Earnings Season and not so Fair Forecasts

You guessed it earnings calls! While Earnings were “top and bottom line beats” almost all around, the calls themselves weren’t so upbeat. Let’s look at the some stats:

The numbers are astounding! Year over year growth for most companies were all north of 60%-70%. While this may not be best comparison given that 2Q2020 was one of the toughest all around, quarter on quarter growth showed upbeat numbers as well.

A few significant highlights:

• Tesla crossed the $1B bottom line mark and with that achievement, Elon Musk will no longer attend earnings calls for Tesla, unless he has something significant to say. Revenue from regulatory credits are reducing while quarterly Auto sales increased 111% year over over.

• Facebook talked about the next generation of social media - the Metaverse. Sounds a bit like the Matrix to me. Basically, we’ll be living our lives on our devices. (I don’t know why people complain about lockdowns then!)

• Boeing turn a net profit for the first time since 3Q2019 and expects to be cash flow positive by 2022. They see air travel returning the pre-pandemic levels by 2023-2024.

• Tim Cook’s notable words: “Progress Made is Not Progress Guaranteed”.

• Microsoft hit an all time high of $290.15 on Wednesday and AMD hit an all time high of $106.97 on Friday.

• AMZN on the other dropped over 7% on Friday after earnings while PINS dropped over 20%. (My take on PINS below ⬇️)

But, even with such blow out earnings, the market remained sombre because of the gloomy forward guidance most of the Big Tech provided. But the recurring theme of all the earnings reports: Supply Chain challenges.

Supply Shortages

Almost all the companies reporting spoke about Supply Chain challenges and Supply shortages. Boeing talked about labor shortages while others like Apple and Microsoft cited component shortages and rising freight rates.

Microsoft’s Surface laptops and tablets were particularly hard hit. Tim Cook said that the iPhone and iPad were going to face shortages soon as well. Apple has one of the most robust supply chain management systems you will ever come across and most of their success has been because they stockpile resources. But, the persistent shortages are now piling up.

I was eager to hear what AMD’s Dr. Lisa Su had to say about the chip shortages but, she wasn’t too forthcoming with details. She did however, say that they worked very hard to deliver the chips for Tesla’s Model S & X, a fact that helped Elon Must deliver over 200,000 cars for the quarter.

LAM Research on the other hand elaborated on their strategy: they are working hard to source from various locations - from factories either relating to their existing suppliers or from new suppliers, if required. They are also looking at using refurbished parts where possible. Lockdowns around the world are setting them back.

Coming back to freight and port issues. The cost of freight has increased over 300% in last one year globally (see the World Container Index Chart below) but, port throughput is improving. This means while costs still remain a concern, demand is returning and supply is responding.

Why it Matters:

With the Pandemic still raging in many parts of the world, we are likely to see a continuation of supply shortages. As demand increases with the re-opening of the economy, inflation will continue to rise. This in turn will force the Fed to increase rates, which will cause markets to decline. So, timing is key.

At the moment, the Core Personal Consumption Expenditure (PCE) price index (which takes out food and energy to reduce volatility) increased by 0.4% in June, below the expected increase of 0.6%, and following a 0.5% increase in May. The annual core PCE price index is a key economic metric because it is the Fed's preferred measure of inflation, which is targeted at 2%. The numbers point to a positive re-opening of the economy but not to the extent that they can be considered “hot”.

In addition, second quarter real GDP grew 6.5% missing estimates of an 8.5% increase. This follows an increase of 6.3% in the first quarter of 2021. This is yet another sign that while the economy is rebounding, the pace is muted enough that the Fed need not take any drastic measures like rate hikes to curb inflation.

So, the Fed Chair’s dovish comments seem warranted and while we see inflationary pressures rising, they really do seem to be transitory.

IPOs of the Week

Quite a few interesting names came to the market this week. I looked at four and here’s my take on each of them.

Duolingo (DUOL)

Duolingo has quickly become one of the foremost apps for learning a new language. My daughter loves the app to practice her French so, when I heard it was listing, I had to dig deeper. I had mixed feelings about the company. I love the concept of making language learning a game. I also love the fact that they’ve tied up with numerous universities and colleges to accept their English Testing program. But the numbers are still weak.

The Company’s top line for 2020 was $162M with a net loss of $15M. DUOL’s losses increased with its revenue during the pandemic. The quarter ending 31 Mar 2021, shows revenues almost doubling from $28M in 1Q2020 to $55M in 1Q2021. But year-on-year losses also increased from $2.2M to $13M in 1Q2021. The company priced at $102 but opened at $140 (pop!). Shares closed on listing day at $139.01.

According to the WSJ, the company is allowing employees with vested shares to sell 25% of those in the first seven days of trading, even though they have a lock-up period of 180-days. I didn’t take a position at open. The valuation seemed a bit rich for me at over $6.5B (40x 2020 Rev). 2Q earnings are out in 2 weeks on 11 Aug 2021 and I’ll decide then.

Traeger Grills (COOK)

Traeger Grills invented the original wood pellet grill in 1987. But, Traeger is more than just a grill manufacturer. According to their S-1: “At the heart of our brand is a passionate and engaged community called the Traegerhood, which includes everyone from casual grillers to competition pitmasters and professional chefs.”

Traeger has converted the simple pleasure of grilling into an experience and a cult… and they are tech savvy. They call their grills IoTs and their proprietary WiFIRE technology allows users to control their grill through the Traeger App, Apple Watch, Google Home or Amazon Alexa. I think it’s a great concept.

The company has done well because of the “stay-at-home” period so, holding on to this momentum will be key. In the past they’ve had operating losses and accumulated deficits still amount to $57M. They also have a fair amount of long term debt at $437M and much of the IPO proceeds will be used to settle the debt.

The company priced 23.53M shares at $18 and the deal was oversubscribed. Shares opened $22 and I managed to take a small position which I will likely increase depending on how 2Q2021 numbers look.

Robinhood Markets (HOOD)

This one’s been overanalyzed to death in the media. The IPO was a flop. I put in a small order at $36, well below the listing of $38… and lo and behold, my order got filled. Matt Levine has a great rundown on how IPOs come to market and what Robinhood did differently. I prefer to remain neutral on this one. But, HOOD was not the only ugly debut.

Dole Plc (DOLE)

Dole is one of the largest fresh fruit and vegetable companies in the world. They have an impressive lineup of assets - land, transportation and storage. Dole has a fantastic supply chain setup. The company has been plagued with rising costs over the years but, they’ve made a turnaround. Dole listed at $16 on Friday with 25M shares. There was a lot of confusion during the week as the IPO was repriced down from $20-$23 with an increase to 30M shares. Needless to say the company didn’t do very well on debut. DOLE closed at 14.50, 9.38% down from IPO price. Ideally, I want to buy a piece of this but not until the price settles.

Around the Markets

Infrastructure Bill

The US may finally have their infrastructure bill and while it may not be the $2T that they were looking for, $550B is no paltry amount.

As a follow on to the infrastructure bill, copper and iron will continue to be in demand. Mining stocks still remain in focus. FCX and NUE are good copper and steel names; with CLF a close third.

Pinterest

PINS dropped 22% after their second quarter earnings on the news that the growth in Monthly Active Users (MAUs) in the US was slowing down. After the first quarter earnings, I’d gradually liquidated my position at almost no profit. It’s not that I think the MAU numbers are troubling but, more that the company’s strategy is troubling. I feel that they’re not innovating fast enough. In today’s market, that’s a death sentence.

I love Pinterest and I can lose myself for hours on the platform. But, while exploring is easy, creating pins is not necessarily so. It takes a while to get the right format and upload it. The business account is still a little glitchy and there’s been no significant change to the platform over the last 6 years that I’ve been using it. The company rode the “stay-at-home” wave and yet did nothing to pivot during this time. I’m not saying they have to be a Nike or Facebook; but, they need to implement changes and until they innovate, I’m not buying in again. They’ve said that they are making changes - shopping is being rolled out in many countries (not mine yet) but, we need those changes sooner, rather than later.

Final Note

Covid is becoming longer and stronger. Most big employers are now forcing vaccines on to people and for good reason. We’re not even close to being out of the woods and the world has not gone back to normal for most. As the Delta variant makes its rounds, the CDC has asked people to mask up again. All this turbulence is hitting the markets and we’re sure to see some uneven price action next week.

Still let’s be optimistic… here’s to wishing you a green week ahead.

Sincerely,

Ayesha Tariq, CFA

Remember, there’s always a story behind the numbers.