CWS Market Review – May 31, 2022

(This is the free version of CWS Market Review. If you like what you see, then please sign up for the premium newsletter for $20 per month or $200 for the whole year. If you sign up today, you can see our two reports, “Your Handy Guide to Stock Orders” and “How Not to Get Screwed on Your Mortgage.”)

The Bear May Not Be Finished

Last week, the S&P 500 gained 6.6% for its best weekly gain in 18 months. That was welcome news, and it snapped a seven-week losing streak. Still, the odds are very high that this is yet another bear market rally.

Unfortunately, this recent bump comes amid a poor overall market. In fact, this year is the worst start to a year, through 100 trading days, in 52 years. It’s the second-worst start in over 82 years (the fall of France was apparently not good for stocks).

The truth is that bear market rallies are common. Investors will typically see several before the real rally begins. Is this latest rally just another head-fake? Probably, but there’s no way to be certain. In my experience, the stronger the bounce is, the less likely it is to last. As a rule, bear market rallies should be assumed to be phony until proven otherwise.

Here’s an updated look at the S&P 500 High Beta Index (black) versus the S&P 500 Low Vol Index (blue).

In plain English, the chart above is risky stocks against conservative stocks. As you can see, it’s been the risky stocks getting hammered while the conservative ones are barely scratched. This latest rally is focused almost exclusively among the risky stocks. That adds to my skepticism.

The simple reality is that it’s hard for me to believe that the market has suddenly changed its outlook when all the previous problems are still there. At the top of the list, the U.S. economy still faces high inflation, and there’s little evidence that things are improving.

Many Americans just celebrated the Memorial Day weekend while facing higher prices for food and gasoline. The highest inflation in four decades is leading the Federal Reserve to (finally) adopt an aggressive policy of raising interest rates. The recent minutes from the Fed made that clear.

Investors should understand that higher interest rates are like kryptonite to stocks. Nearly every market rally has eventually been done in by the Federal Reserve.

Here’s an example from the financial crisis:

The Fed raised rates by 0.25% at 17 consecutive meetings. They overdid it and choked off first, the market and second, the economy.

The Fed meets again in two weeks, and it seems highly likely that we’ll see another 0.5% rate increase. On top of that, there will probably be another 0.5% hike in late July. How high will rates go? I don’t know but I wouldn’t be surprised to see rates rise by 2% before the end of the year.

Fed Governor Christopher Waller said yesterday that he expects to see the 0.5% rate hikes continue. Waller said he supports raising rates until they’re above the “neutral level.” This is the idea that there’s an ideal interest rate where all the parts of the economy come into perfect balance. The problem is that we don’t know exactly where this rate is. Recently, the Fed pinpointed the neutral rate at 2.5%. Still, that’s only a guess.

We’re at an odd crossroads with the economy. Many of the numbers continue to look good, but the outlook for the near future is very pessimistic. I’ve never seen a gap this wide between economic reports and the outlook. The housing market is booming. The jobs market is on fire. Summer businesses are having trouble finding employees. (Hey guys, offer more!) There are now two job openings for every unemployed person. Yet everyone on Wall Street thinks we’re headed back to the 1970s.

Another good example is the strength in corporate profits. In the S&P 500, 375 companies beat Wall Street’s earnings expectations for Q1. While many companies have reported trouble with supply-chain issues, they’re still experiencing strong demand.

Last year was a very good year for corporate profits, and a large part of that was driven by wider profit margins. The problem with margin expansion is that there’s only so far you can push that. Now we’re seeing the pushback, and that’s what has stock traders so antsy.

On Friday, the government said that consumer spending rose by 0.9% last month while after-tax income rose by 0.3%. Households set aside just 4.4% of their after-tax income. That’s the lowest rate since 2008.

The government also updated the Q1 GDP report last week. The Bureau of Economic Analysis now says that the U.S. economy contracted by 1.5% during the first three months of this year. That’s 0.1% lower than the initial report. Don’t let the negative number fool you. Consumer spending was pretty good during the first quarter.

With the income and spending report, the government also updates the personal consumption expenditure numbers. This is important to watch because it’s the Fed’s preferred measure for inflation. For the 12 months ending in April, core PCE rose by 4.9%. That’s down from the 12 months ending in March which was 5.2%. Headline PCE, which includes food and energy prices, rose by 6.3%. Over the last year, home prices were up more than 20%.

On Friday, we’re going to get the jobs report for May. I expect to see more good numbers. Wall Street expects to see a gain of 325,000 nonfarm payrolls, and it is looking for the unemployment rate to fall to 3.5%. That’s a bold forecast but it’s reasonable. The weekly jobless claims numbers are still holding up well. The Federal Reserve recently conducted a survey on consumer health. It found that 78% of respondents say that they’re doing “at least OK.” That’s the highest result in the survey’s history.

Stock Focus: Atrion

I want to revisit Atrion (ATRI), which is a stock I’ve profiled before. Atrion is a great example of a niche company with an amazing track record, and barely anyone knows about them. Atrion makes products for the healthcare field for applications such as fluid delivery, cardiovascular and ophthalmology.

These fluid delivery products include valves that hold and release precise amounts of fluids. This is crucial for areas like anesthesia and oncology. Do you wonder who makes valves for life vests? There’s a good chance it’s Atrion.

Even though Atrion is small (about $1.1 billion in market cap), several of their most successful products are dominant in their market niches. For example, Atrion is a leading U.S. manufacturer of soft contact lens disinfection cases, clamps for IV sets, cardiac surgery vacuum relief valves, minimally invasive surgical tapes, check valves and balloon catheters for the treatment of tear duct blockages.

The company currently has about 400,000 square feet of manufacturing and R&D capacity in three facilities in Alabama, Florida and Texas. Over the past five years, Atrion has steadily increased R&D funding by 5% per year. The firm has also invested $60 million in manufacturing and quality assurance equipment.

Over the last 20 years, Atrion has averaged 6% sales growth and 18% growth in operating income. Most impressively, this growth has been organic, meaning it hasn’t come from acquisitions. Over the last 20 years, earnings-per-share has grown by an average of 20% per year. I also like that Atrion doesn’t have any debt.

The stock has had an amazing run. Since 1990, shares of Atrion are up close to 300-fold. An investment of $10,000 would have grown to more than $2.9 million. Despite the amazing track record, shares of ATRI peaked at $948 in 2019. The stock is down about one-third since then.

Best of all, not a single Wall Street analyst follows Atrion. I can’t say if the company has topped Wall Street’s expectations because there aren’t any expectations. Earlier this month, Atrion reported fiscal Q1 earnings of $4.71 per share. That’s an 18% increase over last year’s Q1.

About the earnings, David Battat, Atrion’s president and CEO, said, “The three primary drivers of performance in the quarter were medical devices used in minimally invasive surgical procedures, consoles utilized in open heart surgeries, and components used to safely deliver therapeutics.”

He added, “The substantial expansion of one of our manufacturing facilities remains on track for completion in the summer of 2023, which will support ongoing projects to increase the number of new product launches as well as the expansion of markets for existing ones.”

Last year, Atrion’s sales rose about 11% and its EPS increased from $17.44 to $18.18. Atrion also increased its quarterly dividend from $1.75 to $1.95 per share. I’m expecting another dividend hike in August. This is a company that has rewarded its shareholders. Not only has Atrion consistently increased its dividend for 20 years, but the company has also paid out several generous special dividends.

I can’t recommend Atrion just yet. I think the shares are still too expensive, but if Atrion dips another 20%, I would definitely be interested.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

P.S. Don’t forget to sign up for a premium subscription: $20 per month or $200 for the whole year!

Posted by on May 31st, 2022 at 10:37 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.