Banks and oil continue to be the two most interesting sectors
Banks and oil continue to be the two most interesting sectors on the stock exchange, both in a temporary bounce and in the slightly longer perspective. But by April, May, you should probably start looking at rotating over to slightly more forward-leaning sectors.
The reporting period
has just begun. My main guess is that the stock market will bounce up for at
least the first two weeks. The reason is that the austerity measures with
higher interest rates and Quantitative Tightening have not yet had time to have
any negative effects on the economy. This means that the Q3 reports may look a
little better than feared and the market has gained height through the last 8
weeks' stock market crash. The rally on Thursday 13 October, which can be said
to be triggered by the inflation figures in the US, is a sign that the stock
market is like a taut spring where the bargain buyers are more eager and
fearless than the sellers are willing to give up and book their losses.
If you back out a little from the day's activity on the stock market and the economy, nothing has improved. Inflation is so high that central banks will continue to raise interest rates. In 2023, it will lead to a recession, perhaps even a relatively deep one, due to the imbalances built up over the years with unbridled stimulus. My overall strategy is therefore exactly in line with what it has been throughout 2022, i.e., to sell expensive companies and industries on a setup. In practice, this means stocks in discretionary consumption and technology, especially if the companies do not have positive cash flows. The higher the Price/Sales value and the worse the cash flow situation and dependence on active purchase decisions from consumers and companies, the harder I push the sell lever. Companies whose share price is based on hopes of very high growth for several years, I think, are particularly vulnerable when the recession brings dashed hopes. This primarily applies to companies such as Tesla, Cloudflare, Service Now, Shopify, Lululemon, Robinhood and Snowflake. But even supposedly stable and reliable giants such as Microsoft, Apple and Amazon will see forecasts lowered, while reduced investor optimism and outflows or reweighting to interest rates cause valuation multiples to fall for them as well.
But if we instead focus on October, then I believe in a reflexive rise due to a relative relief that the earnings reports were not as weak as feared. There are also quite a few stocks that are already cheap today. Sure, even these can also be dragged down more or less temporarily in a general stock market downturn, but with the potential for both a short-term uptick now, and the knowledge of having bought the companies' future cash flows at a discount, the total calculation becomes quite palatable.
I especially think the big oil companies and their subcontractors look extremely attractive. I have highlighted ConocoPhillips several times in the past and although the price is currently hitting new highs of over 122 USD, the company could still be considered strangely cheap. The average forecast for 2022 is earnings per share of nearly $15. The Price / Earnings P/E ratio is thus still only 8. Normally, a company whose products are both a scarce commodity and a necessity to keep the economy running would be valued at least in line with the average on the stock market over time, i.e. around P/E 16. I For Conoco, that would equate to a share price of $240. But when it comes to the oil companies in particular, it seems that the undeservedly negative label they have received from the ESG movement means that despite the oil shortage, despite the prospects for much higher oil prices and thus sharply growing profits, despite the fact that oil is a prerequisite for being able to build solar and wind farms, the profit multiples have parked at half of the stock exchange. But as expensive tech and engineering stocks are devalued, there is a good chance that there will be a rotation into oil stocks and thus a revaluation of the entire sector.
I don't really dare to hope that you reach well-deserved multiples on today's double, but it is enough that the profit is maintained at 15 dollars and the multiple rises to 10 or 12 if the sector receives wider confidence from the market that the price will rise 25-50 percent. However, average forecasts in the market are for a year of stagnant earnings and then a collapse to $10.50 per share in 2024, presumably due to an expectation of weaker oil prices or reduced production, when the opposite may well be the case on both counts. There is a non-trivial probability that sometime in the next two years the price of oil will rush to record levels of $150 under certain geopolitical and weather conditions. That would more than double the profits of COP and Occidental. It's not the base case, but you get the base case for 8 times the profit. The super case of 3-4 times earnings is only as extra spice and plaster on the wounds if the world were to get into serious trouble.
It's rarely a good idea to chase soaring stock prices, especially in the face of an approaching recession in companies whose demand depends on how much economic activity there is in the world, but keeping the oil sector in the back of your mind and buying on weak days has been a winning strategy this year. I've just barely managed to step in and out of COP a few times without being sidelined as the price rallied. I have also managed to get into the oil service company Schlumberger ($44 now) relatively cheap ($34-$35).
A similar sector, which like the oil companies also forms the framework of the economy, is Nordic retail banks. They are also traded at multiples below 10, despite high dividend yields and very good conditions for profit growth when interest rates rise and the entire economy becomes nominally larger thanks to high inflation. Of course, the provisions for credit losses will increase somewhat, but the banks are extremely well capitalized and households have no problems servicing their loans and paying their electricity bills. However, there is not much money left over for new sports equipment or a constantly fashion-updated wardrobe, not to mention furniture and apartment renovation.
Swedbank, Handelsbanken and Danske Bank feel like very safe cornerstones in the portfolio alongside the oil companies. I expect very strong bank reports over the next four quarters. The same for the oil companies. This means that you could buy in today, especially in the banks, but save the large volumes for the oil companies for weak days. Unfortunately, you will probably then have to stand by and watch the rates rush on for a few more weeks before Santa's banter takes over after the reporting period.
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