The Amazon conference call above explains that the “stay at home trade” which helped Amazon [and other big tech] is ending and traditional “reopening trades” like travel, leisure and energy should experience an earnings ramp which should benefit from this rotation.
Senator Josh Hawley’s book, The Tyranny of Big Tech, lays plain the monopolistic position of big tech companies like Facebook, Inc., Alphabet, Inc. aka “Google”, and Apple Inc. He further details their grip on the market and increasingly close alignment with the federal government which parallels the monopolistic robber baron period of the late 19th century. Antitrust legislation followed the robber barons and loosened their lethal grip on the American worker.
Hawley writes that of those using social media, 99% use Facebook, comprising 70% of all adults in the country. Google performs 9 out of 10 searches and its Android smartphone has 85% market share. Amazon Prime has 126 million users. Apple’s App Store generates $500 billion annually in commerce. Big techs control is becoming a growing source of antitrust and anticompetitive litigation. These massively dominant positions will cause the law of large numbers to limit the high earnings and revenue growth that has made these companies world leaders and massively rewarding investments.
Historically, when growth stock earnings slow, growth stock price-to-earnings multiples contract, and their share prices decline with their multiple contractions. Our fear is that, as selling begets more selling, these big tech stocks will succumb to a negative feedback loop of selling. Then momentum and index investors will turn from buyers to sellers. As information technology has a 27.6% share of the S&P 500, a period of technology weakness will induce the same negative feedback loop of selling in the S&P 500 where momentum and index investors could also reverse from buyers to sellers.
On the flip side to contracting earnings and margins that are unfolding in tech stocks, we see upside opportunity in commodity stocks. We like natural gas stocks, steel stocks, metallurgical coal stocks, and select energy stocks. Due to the economic cyclicality of these stocks, as the economy recovers, we expect improving earnings trends. Further, commodity cyclical stocks should have considerable operating leverage as commodity prices are rising which allows these companies to enjoy both rising demand and rising prices.
This week, Charif Souki, the CEO of Tellurian, Inc. (TELL), explained that the IEA reported that global electricity demand is growing faster than the supply of renewable energy. This clearly fits our thesis that natural gas demand will be a winner in the energy space as clean fossil fuel is both replacing coal and oil and filling the demand gap from renewables.
Tellurian also announced a contract with Shell Energy, which should give them the capacity to secure financing for their Driftwood project. During the announcement Shell Energy EVP Steve Hill said “LNG demand is expected to nearly double by 2040” affirming our bullish view on natural gas and LNG. This Shell Energy deal offsets recent uncertainty from the TotalEnergies, SE cancellation, which we used as a buying opportunity. Tellurian estimates $6.6 billion per year in EBITDA based on its completed 5 plants and 27.6 MTPA project plan. In the last 10 weeks, Tellurian has secured agreements with Gunvor Group, Vitol, and Shell Energy for a total of 9 MTPA. Given Tellurian’s current $1.6 billion market capitalization, and the experience of CEO Souki, who co-founded and was the CEO of Cheniere, we are quite optimistic about TELL.
This week, US LNG prices were $4/mmbtu and $14/mmbtu in Japan. With strong demand from Japan and China, we see significant upside for TELL over the next several years which matches nicely with our commodity thesis.
Antero Resources, Inc. (AR) and Antero Midstream, Inc. (AM) reported strong earnings this past week. Their Utica and Permian Basin locations combined with their industry-leading low-cost production, continue to deliver solid earnings which have made these stocks top holdings for our clients.
- Steel and Metallurgical Coal:
Steel prices, like other commodities, have been on a tear this year. Because global demand should rise with the global economic recovery, steel stocks should enjoy higher prices, higher margins, and higher profits in the next two years. Two steel stocks we like are US Steel (X) and Cleveland Cliffs (CLF). We provided a link to reports by KCI Research on Seekingalpha.com which also identified the Antero investments last year — when some questioned Antero Resources’ viability and the energy sector was in a severe decline.
The chart below shows steel prices at record highs, which implies that future earnings should also rise meaningfully. Consensus earnings for US Steel are $10.28/share for 2021 and continued earnings growth in 2022 is expected by KCI. With a closing price of $26.48/share of X, we expect to see a higher stock price if steel prices continue to surprise the upside.
Source: KCI Research and SteelBenchmarker.com
Like US Steel, Cleveland Cliff’s (CLF) has enormous operating leverage and earnings momentum. CLF’s 2021 EBITDA guidance has risen from $3.5 billion to $5.5 billion since April. The company expects to pay down all of its $5.4 billion in debt in 2022, and just retired a $1.2 billion preferred.
One special situation is in metallurgical coal, specialty coal needed in manufacturing steel. If demand for steel remains strong, demand for “met” coal should be enormous. Warrior Met Coal (HCC), an Alabama-based coal company offers unique upside potential. HCC was also positioned to pay down its debt in May when premium met coal was $100 per ton, today it is $222/ton according to KCI. This doubling of the met coal sales price should drive significant upside to its earnings. Unfortunately, the company is coping with a strike; however, with higher prices and strong earnings, a resolution of union wages should be resolved soon. With earnings due out August 4th, HCC is another commodity cyclical we like as a commodity inflation beneficiary.
The market is at great risk despite the flood of monetary stimulus that has created an unprecedented cushion to stock prices. With the economic recovery now firmly in place, peak earnings are now priced into the market. A significant slowdown in the GDP growth rate from q2’s 6.5% to 2.5% in 2022 is being forecast by Goldman Sachs. Inflation is poised to crimp earnings but could help certain commodity cyclicals including energy and steel.
With the preferred valuation metrics of Warren Buffett and Robert Shiller are at historically record levels, assuming this period is like the roaring 1920s would be a dangerous miscalculation. We expect a rocky second half and a 10% correction would be quite reasonable. However, long-term trends could prove far worse if inflation presses above the 2% range and market multiples collapse due to margin pressures and decelerating earnings like those from big tech.
There are markets and investments where earnings and valuations should grow in the years ahead. Like the 2000-2003 bear market, we expect money will rotate into commodity cyclical, small-cap stocks, precious metals, and emerging markets while the SPY and QQQ suffer meaningful downside.
These slow summer days are an excellent time for diligent risk management and investment review.