CWS Market Review – November 14, 2023

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Stocks Soar on Soft Inflation Report

Finally, some good inflation news!

This morning, the government said that inflation was unchanged last month. That was 0.1% below expectations. Not surprisingly, the report was helped by falling energy prices. Over the last year, inflation is running at 3.2%.

This is a very good report. Bear in mind that inflation was running very hot in September (+0.4%), so this report is a nice change of pace.

The inflation story isn’t just about energy prices. The core rate, which excludes food and energy, rose by only 0.2% last month. That was also 0.1% below expectations. Over the last year, core inflation is up by 4%. That’s the slowest 12-month rate in over two years.

Here’s a look at the monthly seasonally-adjusted core rate. My apologies for the econ jargon, but this way, you can really see how the threat of inflation has faded over the last year:

Here are some details:

The flat reading on headline CPI came as energy prices declined 2.5% for the month, offsetting a 0.3% increase in the food index. It was the slowest monthly pace since July 2022.

Shelter costs, a key component in the index, rose 0.3% in October, half the gain in September as the year-over-year increase eased to 6.7%. Within the category, owners equivalent rent, which gauges what property owners could command for rent, increased 0.4%. A subcategory that includes hotel and motel pricing dropped 2.9%. 0.4% for September.

(…)

Vehicle costs, which had been a key inflation component during the spike in 2021-22, fell on the month. New vehicle prices declined 0.1%, while used vehicle prices were off 0.8% and were down 7.1% from a year ago.

Airfares, another closely watched component, declined 0.9% and are off 13.2% annually. Motor vehicle insurance, however, saw a 1.9% increase and was up 19.2% from a year ago.

Wall Street celebrated as it now looks like the Federal Reserve won’t be raising rates anymore this cycle.

In Wall Street’s mind, there’s nothing better than lower interest rates. On Tuesday, the S&P 500 rallied for the tenth time in the last 12 sessions. For the day, the index gained 1.9%. The S&P 500 is already up 7.2% in November and the month isn’t quite halfway over.

Futures traders think there’s only a 0.2% chance the Fed will hike next month. One month ago, the odds for a December rate hike were at 30%. Traders think there’s a 0.2% chance it will hike in January. By May, the market says there’s a 65% chance that the Fed will start cutting rates.

On our Buy List, Trex (TREX) was up more than 7.5% today. The deck-maker recently beat earnings and raised guidance. Celanese (CE) rallied 6.7% on Tuesday, and Polaris (PII) was up close to 6%.

Tuesday’s market was heavily concentrated on higher-risk areas of the market. On days like today, I like to look at the spread between the S&P 500 Low Volatility Index and the S&P 500 High Beta Index. On Tuesday, High Beta gained 4.45% while Low Vol gained 1.24%.

What’s going on? I think a lot of investors mistakenly believe that the promise of lower rates will lead us back to the glory days of 2020-2021. That’s when rates were at 0% and the government was spending money to boost the economy. The Fed effectively took risk out of the investing equation and high-risk areas soared.

As I look at the stock market and inflation numbers, I can’t help wondering how overly complicated the game appears. Perhaps it’s as easy as leaving the market when inflation hits 7% and then coming back in when it drops below 7%. That’s an easy rule that’s pretty much worked perfectly. You can see it in this chart. The black line is the rate of inflation and it follows the left scale. The S&P 500 is the blue line and it follows the right scale.

The earnings numbers for Q3 are almost all in. It looks like the S&P 500 will report earnings growth of 4.1%. What about for Q4, which is already halfway done? Analysts are expecting Q4 earnings growth of just 3.2%.

But after that, things are expected to improve. Analysts expect earnings growth to improve to 6.7% for Q1, and 10.5% for Q2. FactSet notes that while these projects are down since September, they’re still above the results for Q3. In other words, not only is Corporate America still profitable, but earnings growth is accelerating.

The fastest-growing sectors are projected to be Communication Services (19.9%), Consumer Discretionary (16.5%) and Information Technology (15.2%). The stocks that are expected to contribute the most to earnings growth for Q1 are Nvidia, Amazon, Meta Platforms and Alphabet. Without these four, the S&P 500 would have earnings growth of 3.2%. With them, it’s 6.7%.

Stock Focus: Simulations Plus (SLP)

I’ve been a fan of Simulations Plus (SLP) for some time now. It’s a neat company that’s not well known. SLP’s market cap is just over $725 million and only three analysts follow it. The stock rallied 5.2% today. Incidentally, today was also SLP’s Investor Day.

Simulations Plus makes software that lets drug companies simulate tests of their products in the virtual world before using any human or animal test subjects. That’s a major cost-saver for drug companies.

Simulations Plus helps streamline the R&D process by making it faster and more efficient. Not only is this cost effective, but it also helps drug companies in dealing with time-consuming regulatory hurdles.

In fact, there are times when the results from SLP’s products have allowed companies to waive clinical studies. The cost savings are substantial. This means drug companies don’t have to deal with the time and expense of recruiting test subjects and analyzing test results.

By using SLP’s software, drug companies can experiment with many variables like fine-tuning dosage amounts. Companies can also see potential harmful side effects. Another important factor is that companies can identify treatments that have no benefits.

In healthcare, cost control is a major issue. That’s why SLP’s products are in heavy demand. A great business to buy is one that helps other companies control their costs.

In many ways, I think what Simulations Plus does for pharmaceutical researchers is closely akin to what Ansys (ANSS) does for engineers. By sitting at a computer, an employee can efficiently iron out a lot of kinks before experimenting in the real world. Simulations Plus is also branching out from their core customer base of drug companies. They work with consumer products companies to see the side effects of things like pesticides.

Unfortunately, the shares have not performed well over the past few years. That could make it a compelling buy.

Simulations Plus recently reported its fiscal-Q4 earnings. For the quarter, SLP’s revenues increased 33% to $15.6 million. The company’s gross profit grew 35% to $12.3 million.

For the quarter, the company earned 18 cents per share. That matched Wall Street’s consensus although I don’t know if three analysts count as a consensus. The stock dropped 15% after the report.

For all of last year, SLP’s revenue grew 11% to $59.6 million, and earnings increased from 60 cents to 67 cents per share.

For the new fiscal year, SLP sees revenues ranging between $66 million and $69 million. That works out to a growth rate of 10% to 15%. For earnings, SLP sees profits ranging between 66 cents and 68 cents per share. I’m particularly impressed that SLP can maintain gross margins that are nearly 80%. Simulations Plus pays out a small quarterly dividend of six cents per share.

As much as I like this business, valuation is still a concern. Going by SLP’s latest guidance, the shares are going for 50 times forward earnings. That a lot for any stock.

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

– Eddy

P.S. If you want more info on our ETF, you can check out the ETF’s website.

Posted by on November 14th, 2023 at 6:38 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.