Valuations: Half Full?

Image courtesy Nitat Termmee/Getty

Markets Today

U.S. markets ripped higher as investors went with the glass half-full approach to start the holiday-shortened week, ignoring the headlines about mounting coronavirus cases around the world and a false start in the economic recovery. The WHO says the worst is yet to come, but investors weren’t hearing any of it.

Shares of Boeing (BA) climbed 12% on positive news about its 737 Max test flights, helping to power the DJIA to 2.2% gains. Shares of Apple (AAPL) and Google (GOOG) also posted strong gains, lifting the S&P 500 and the Nasdaq. Even Facebook (FB) managed gains, despite an exodus of advertisers leaving the platform citing hate speech and other content they find objectionable. With one day to go, June may end with U.S. markets higher for the month, despite a surge in volatility and economic pessimism.

The Fed announced the list of the 800 companies it is buying bonds from, extending its safety net under public companies, their debt holders, and their shareholders. It is an unprecedented monetary policy maneuver, but equity investors seem to like it.

We’ll see how this test flight goes.

Sad news in entertainment… Cirque du Soleil is reportedly filing for bankruptcy protection. Bring on the clowns…

Headlines:

The Supreme Court ruled to allow the Consumer Financial Protection Bureau to continue operating, but it said that the director of the watchdog can be removed by the president of the United States “at will.” The decision, written by Chief Justice John Roberts, agreed with a California-based law firm’s argument that the CFPB’s leadership by a sole director who was removable “only for cause” violated the separation of powers rule under the U.S. Constitution.
The National Association of Realtors’ index of pending home sales increased 44.3% to a three-month high of 99.6, after falling in April to the lowest level in records back to 2001. Even with the outsize advance, the index is below the pre-pandemic high of 111.4, reached in February.
Shale oil pioneer Chesapeake Energy has filed for Chapter 11 bankruptcy as COVID-19 sinks oil demand. It plans to eliminate $7 billion in debt, and it has secured $925 million debtor-in-possession financing and $2.5 billion exit financing from its lenders. Term loan lenders and secured note holders will also backstop a $600 million rights offering upon exit.
Coty (COTY) will buy a 20% ownership interest in Kim Kardashian West’s beauty business for $200 million. In January, it acquired a 51% stake in the reality star’s half-sister Kylie Jenner’s brands. Shares of COTY climbed 13% on the day.
Apple plans to ship the iPhone 12 without EarPods and power adapters in the box, according to famed analyst Ming-Chi Kuo. This is meant to offset the cost of new 5G components and maybe even boost sales of AirPods. Kuo also says two new iPad models, with 10.8-inch and 8.5-inch displays, will be launched in the next year.
Gilead Sciences said it will charge the U.S. government and other developed countries $390 per vial for its coronavirus-fighting drug remdesivir, or about $2,340 for a typical five-day course of treatment. In a statement released Monday, Gilead said it would offer this price to developed countries around the world, in order to create a one-price model that would avoid the need for country-by-country negotiations.
Boeing’s grounded 737 Max planes began test flights under FAA oversight today. If the 737 tests go well, Boeing will return the planes to service around the end of the year with new automated flight control systems. Shares of Boeing climbed 13% in today’s session.
China’s Luckin Coffee has said it will delist from the Nasdaq after a massive fraud scandal. It has received two delisting notices from the exchange and has decided not to appeal. The board of directors is also pushing for the removal of Charles Zhengyao Lu as a director and the chairman. The stock has fallen to $1.38 after reaching $50 in January.

chart courtesy Morgan Stanley

Valuations: Half Full?

The stock market’s impressive rally off of its March lows has caused a lot of hand-wringing among investors lamenting excessive valuations in the face of economic devastation. But, there’s another way of looking at valuations that could suggest more upside for stocks.

The S&P 500 is trading at 21x the consensus forward earnings per share of $143. It was as high as 23x just a few weeks ago. While those valuations are lofty, bullish strategists like those at Morgan Stanley suggest that they are not that high when you consider that earnings estimates have bottomed. In other words, earnings can only improve from here if we continue to recover, which means that valuations won’t look so stretched once profits catch up to share prices.

If sky-high valuations scare you, don’t look at the Nasdaq Composite Index. It is trading at 34x its 23-month forward PE ratio.

chart courtesy Goldman Sachs

Airlines May Be Grounded for a While

Despite Boeing’s positive news on its test flight, the airline industry it sells to is still in dire trouble. While bookings have increased, especially for domestic flights, international and business travel is below many forecasts.

According to Goldman Sachs, airline traffic trends are below its previously reduced forecasts, and the team is now incorporating a significantly less steep recovery to 2019 levels of demand, particularly for corporate and international markets. It has reduced airline sales and revenue forecasts through 2022.

chart courtesy CME

Heavy Metals

Gold has been the undisputed king of the heavy metals in 2020 as investors have flocked to its relative safety. But don’t sleep on copper. Copper is poised for its best quarter since 2010, helped by optimism over a stronger-than-expected demand rebound in China and mounting supply concerns in South America. It’s benefitting from both demand and supply fears, which is a rare place to be in the 2020 economy.

Copper futures have surged about 20% this quarter and climbed above $6,000 a metric ton last week for the first time since the pandemic began. A report Friday showed hedge funds cut bearish bets on U.S. copper futures and options to the lowest since 2018. If you are looking for a good proxy for economic recovery, keep an eye on Dr. Copper.

(chart courtesy YCHARTS)

Shares of Kohl’s climbed 10% on optimism that consumer spending will remain strong. Shares of Simon Property Group rose 10% today as America’s largest mall owner announced dozens of reopenings across the country.

Shares of Noble Energy are down by over 3.5% after Delek Drilling, the oil company’s Leviathan and Tamar offshore natural gas fields partner, announced a projected second-quarter drop in gas volumes by 13%. TechnipFMC, another oil company, fell by over 3%.

Word of the Day

Relief Rally

A relief rally is a respite from market selling pressure that results in an increase in securities prices. Sometimes it happens when expected negative news ends up being positive, or it’s less severe than expected.

Market participants price in many different types of events, in addition to corporate earnings. Examples include election results, policy interest rate changes by the U.S. Federal Reserve, and new industry regulations. Any of these events can trigger a relief rally when the news is not so bad, relative to widespread negative expectations.