THE BULL MARKET REPORT for December 18, 2023

by Scott Martin | Dec 17, 2023 | Weekly Newsletter 7pm Sunday

Market Summary

The Bull Market Report

We were feeling pretty good a few weeks ago. Now, the Fed has given us permission to openly cheer. The BMR universe is up 40% YTD, with portfolio after portfolio soaring faster this month than the Nasdaq and the S&P 500 put together. At this point, our stocks are poised to leave the market as a whole far behind, and it isn't hard to understand why. Investors are finally looking forward to a future that's tangibly better than the past. If there's a recession in 2024, the odds are good that it will be relatively mild. From a corporate perspective, the recession that matters has already come and gone. We're back in a world where the fundamentals are improving again instead of deteriorating as they did for much of this year. Yes, earnings are shifting back into record-breaking gear.

The Dow Industrials have responded by recovering their pre-bear-market highs and then moving even farther forward into record territory. While the Nasdaq and the S&P 500 aren't quite there yet, the pain we endured last year has almost entirely evaporated. The BMR universe, for example, is where it closed out 2021. That's an important milestone because it means that for the first time in months, investors who held on through the Fed's aggressive tightening cycle are on the verge of breaking even. They haven't lost appreciable money. The only thing they've lost is time. At the rate our stocks are moving, we're making up for that lost time fast. Sooner or later, we'll be back on our long-term trend, and the way statistics work means that after a period of underperformance, we can look forward to accelerated gains for at least a little while to come.

In other words, the best may be yet to come. The earnings cycle that starts next month will almost certainly be the strongest we've seen in the 12 months. After that, the year-over-year numbers can get even better as corporate executives shake off all the pressure on their operations and get back to work. Inflation has receded to something like "normal" historical levels. Profit margins remain robust. Supply chains have become far more resilient than they were before the pandemic. A new wave of technological innovation is already boosting productivity, enabling worker-starved companies to do more with the people they have. Mass layoffs like we saw in 2008 or 2020 look relatively remote at this stage.

Of course, additional shocks can create setbacks. But life is full of shocks and as we love to say, Wall Street has survived generations of shocks (world wars, social upheavals, oil embargos, pandemics, credit crashes, high and low bond yields, high and low taxes) and thrived. That's "normal." Something new emerges to worry about and investors find a way around or over that wall of worry. Stocks continue their long record-breaking trajectory. In a bear market, it's easy to forget that the S&P 500 has spent most of its life chasing from peak to peak, taking us all to levels of unprecedented wealth along the way. This isn't simply our optimism talking. It's historical fact.

Granted, the road is never smooth from day to day, week to week, or even year to year. But the ultimate direction is never really in doubt. Everyone at the Fed who votes on monetary policy currently thinks interest rates will go down in the coming year. Nobody seriously thinks rates will go up. The drag we feel from that direction is unlikely to increase. This is as bad as it gets in this cycle. And when you're already feeling the worst, those statistical rules tell us that things are going to get better. All we need to do is keep our eyes open and remain disciplined enough to stay in the market waiting for that reward. What we've weathered in the last few months was simply the bears struggling to reassert their relevance. We just saw the so-called "bond king" Jeffrey Gundlach try to argue that 10-year bonds yielding less than 4% is a red flag when two short months ago he was worried that 5% was going to poison the economy.

There's always a bull market here at The Bull Market Report. As always, we need to talk about several of our favorite stocks, leaving The Big Picture to delve into a few of the "defensive" themes we like a whole lot less in this environment. The Bull Market High Yield Investor dissects a few of the things Fed Chair Jay Powell said this week that resonate with our investment philosophy, as well as our thoughts on the economic landscape as a surprisingly great year winds up. The holidays are coming. Santa is here.

Key Market Indicators

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The Big Picture: Check Your Defense

A lot of investors stayed sidelined this year after the 2022 bear market crushed any confidence in the market they had left. After all, the pundits told them, a recession was imminent and exposure to stocks could only add to the pain. But sometimes a defensive posture is the surest way to fail. Start with the bond market. If you bought 1-year Treasury paper a year ago, it’s maturing now. You’ll get your money back, plus 4.65% interest. There was no risk there. However, the money you’re getting back is worth 3.1% less than it was at the end of 2022, thanks to inflation. The interest payments don’t stretch as far either. All in all, for every $100 you put in, you’re getting the equivalent of $101.40 back. And in the meantime, everyone else was passing you like you were standing still. The S&P 500 gained 22% in that same 12-month period. The Nasdaq jumped a staggering 48%.

Adjust for inflation all you want, but those investors are still significantly richer than they were when you parked that $100 in the bond market where it wasn’t vulnerable to much besides opportunity costs. Stock investors gritted their teeth, closed their eyes, and jumped. They were rewarded for that calculated risk, that leap of faith. And not every bond investor was foresighted enough to buy the actual bonds and hold to maturity. Long-term bond funds are down a net 6-7% in the last 12 months. Yes, it is possible to lose money in the Treasury market when other people are buying high and selling low on your behalf.

Likewise, investors who wanted to stay in the stock market but clung to the “defensive” sectors missed their shot at the dramatic recovery. In effect, those who were in aggressive areas of the market during the bear cycle locked in their losses while locking out the rebound that followed. Utilities are down 9% over the past year. They lost money. Cash is flowing into areas of the economy that are more vibrant and have the power to rally when the bulls are in charge. Defensive consumer stocks (think Big Food and grocery stores) are down. Don't get us wrong, we remain committed to our defensive line, but we aren't going near areas of the market that are clear losers. They rarely do well in an economic downturn. It’s just that they rarely drop hard. They preserve more value than other stocks when the market as a whole takes a dive.

In other words, there is rarely a way to make real money unless you can leverage them with options like some people try to do. What these sectors are all about is protecting existing capital. If you already have more capital than you need, a strong defense is a decent way to hold onto more of it for a longer period. But most of us want to build wealth. We want more than we have. That means a strong offense. Think technology, communications, and discretionary consumer stocks. Industrials. These companies have what it takes to grow. Sometimes that proposition falters, but over time, they run farther to the upside than the downswings take away.

Look at the Industrials. Say you bought the sector on the brink of the COVID crash. You made about 25% in the years that followed until the 2022 bear market got in the way. At the very worst moment of the bear cycle, your initial investment showed a slight loss. Today, about a year from that bear bottom, your initial investment has recovered all lost ground and more. You’re up 35% across the cycle. That’s a strong offense. The gains are bigger than the losses. You end up ahead. Cycle after cycle, you get farther ahead.

How about utilities? Down a net 9% across the same period. How about a bond fund? Down 20% counting dividends. Ouch. The defense was lethal. Gold did well, but gold is a hedge against inflation. And a lot of people were desperate for an inflationary shield in the last few years. We would have rather been in gold than bonds. Thanks to our SPDR Gold Shares ETF, we are. But then again, we are always happy to stay in stocks. To each their own. Feel free to tell us how you feel! Your feedback helps to guide our recommendations to fit your needs.

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BMR Companies and Commentary

The Carlyle Group (CG: $42, up 13% last week)
Special Opportunities Portfolio

Alternative assets manager The Carlyle Group posted a smaller-than-expected but tangible drop in earnings during its recent third-quarter results. The company posted $780 million in revenues, down 45% YoY, compared to $1.4 billion a year ago, with a profit of $370 million, or $0.87 per share, down from $640 million, or $1.42. It, however, posted a spectacular beat on consensus estimates during the quarter.

Private equity giants such as Carlyle have struggled in recent months owing to high interest rates, macro uncertainties, and geopolitical conflicts putting a dampener on M&A activities. This, however, didn’t stop the company from realizing proceeds worth $5.6 billion from asset dispositions during the quarter, as it deployed $4.1 billion towards new investments and acquisitions, bringing it to $12.6 billion YTD.

The Carlyle Group is a global investment firm that specializes in alternative asset management, primarily focusing on private equity, real assets, and private credit. They manage a staggering $380 billion in assets under management as of this moment, making them one of the world's largest private equity firms.

Here's a breakdown of their business, an IN-DEPTH LOOK:

1. Private Equity:

Carlyle's bread and butter. They invest in established companies across various industries like aerospace, consumer, defense, energy, healthcare, technology, and more. They typically acquire majority or controlling stakes in these companies, aiming to improve their operations and drive value creation before selling them later for a profit. Think of them as financial alchemists, turning underperforming companies into gold.

2. Real Assets:

This segment focuses on investments in infrastructure, real estate, and energy assets. They invest in things like airports, ports, pipelines, warehouses, renewable energy projects, and even student housing. Carlyle aims to generate stable income and long-term capital appreciation through these investments.

3. Private Credit:

This newer arm provides financing to mid-sized companies that often struggle to access traditional bank loans. Carlyle offers various debt solutions, including senior loans, mezzanine debt, and distressed debt, catering to different risk appetites.

What makes Carlyle so good at what they do? Here are some key factors:

Experienced Team: Founded in 1987 by a group of seasoned Wall Street veterans, Carlyle boasts a team with extensive expertise in finance, investing, and operations.

Global Reach: With offices in 28 cities across six continents, Carlyle has a deep understanding of different markets and economies, allowing them to identify promising investment opportunities worldwide.

Industry Focus: They have a strong track record in specific sectors like aerospace, consumer, and healthcare, giving them valuable insights and relationships within these industries.

Operational Expertise: Carlyle doesn't just invest money; they actively work with portfolio companies to improve their operations, streamline processes, and drive growth.

Strong Network: They have built strong relationships with investors, governments, and other industry players, giving them access to deal flow and valuable information.

The company is like a well-oiled machine, seamlessly navigating the complex world of alternative investments and generating significant returns for its investors. Carlyle’s funds have shown remarkable resilience in the face of headwinds. While capital market activity remains a bit weak, there has been a steady recovery during the third quarter, and this coupled with the Fed’s recent pivot on interest rates indicates a strong possibility of good times ahead.

The firm’s fundraising activity has slowed a bit with the new higher-interest-rate environment that we have been in this year, at $6.3 billion during the quarter, down from $8 billion a year ago, bringing total assets under management to $380 billion, up 3% YTD. It now has dry powder that is ready to be invested of over $70 billion, as it looks for new opportunities across private equity, real estate, and credit to unveil themselves.

Despite the challenging conditions, the stock is up by 40% YTD but is down 30% from its all-time high of $60 two years ago. It currently offers remarkable value, as well as an annualized yield of 3.3%. The company stands to unlock substantial value going forward. It has a strong balance sheet with $1.7 billion in cash and $9.2 billion in debt. Our Target is $45 which we are raising today to $53, and our Sell Price is $28 which we are raising today to $34.

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SPDR Gold Shares ETF (GLD: $187, up 1%)
Special Opportunities Portfolio

The largest gold ETF in the world by a wide margin, the SPDR Gold Shares ETF is looking more upbeat than ever heading into the new year. Gold briefly traded above $2,100 an ounce early this month, setting a new all-time high, before falling to its current level of $2,030. Following a mixed year, it is now up by 10% YTD since gold prices started to rally a few months ago. With prices near all-time highs, we expect this rally to continue into 2024, even as broader consensus anticipates a soft landing for the US economy.

Gold prices have seen significant volatility in recent weeks, mainly owing to the shift in investor sentiment, and the decline in post-pandemic inflation that has prompted the Fed to end its hawkish stance. That being said, there are still signs of weakness in the US economy. Gold is a vehicle for wealth preservation and hedging.

In addition to this, central banks across the world are increasingly stockpiling gold in response to the rising national debt in the US, along with a debt crisis brewing in the broader world economy. There is also the growing institutional demand, during this period of growing geopolitical tensions in several conflict regions.

During the upcoming year, many factors in play will decide the direction of precious metals. A hard landing or recession for the global economy would send investors running for cover, and prompt the Fed to cut rates, making gold more attractive. Similarly, while high interest rates have a negative correlation with gold, staying higher for longer can make the yellow metal a lot more attractive.

Following a disappointing show since the pandemic, gold is stirring once again, and there are few better ways to gain exposure to it, than the SPDR Gold Shares ETF. With a nearly two-decades-long track record, an expense ratio of just 0.4%, and robust liquidity (8 million shares a day on average), no other fund even comes close. We’re sure you know this, but in case you don’t, the SPDR Gold Shares ETF actually owns gold bars. The current level of assets owned (gold) is $57 billion. It is hidden away in HSBC Bank USA, London, as well as other undisclosed locations. Guess why they are not disclosing the locations! Our Target is $190 and our Sell Price is $160. We are raising both to $215 and $175.

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Visa (V: $258, up 1%)
Financial Portfolio

Global payments giant Visa released its fourth quarter results recently, reporting $8.6 billion in revenues, up 11% YoY, compared to $7.8 billion a year ago. The company posted a profit of $5.6 billion, or $2.27 per share, against $4.2 billion, or $1.93, with a beat on estimates on the top and bottom lines. It further posted an upbeat guidance for the new year, sending the stock on an extended rally ever since. Every time we write about Visa and mention their profits, we are in awe. Look at those numbers above. On $8.6 billion in revenues, they reported $5.6 billion in profits. We must say there are very few, if any more profitable companies on a percentage of revenues. Apple is good at 30%, but Visa is insanely good at 65%, after tax.

The company’s full-year figures were just as exceptional, with $33 billion in revenues, up 11% YoY, compared to $29 billion a year ago. It posted a profit of $17 billion, $8.29 per share, against $15 billion, or $7.01. Despite being faced with a wide variety of headwinds, the company has continued its ascendant streak, made possible by its growing partnerships and integrations across the ecosystem.

During the quarter, the company posted robust performances across core operational metrics, with total processed transactions at 56 billion, up 10% YoY. This was followed by a similar growth in payments volume and cross-border volumes at 9% and 16%, respectively. This was once again made possible by Visa’s growing penetration across geographies, use cases, and product classes.

Its value-added services are helping unlock substantial value for banks, merchants, and financial institutions, all the while creating substantial competitive moats for the company. Visa’s tap-to-pay, payment account tokenization, and business expense management tools are a few of the many products, services, and solutions that the company has unveiled in recent years, that have since gained traction.

The stock is up 24% YTD, scaling new heights each passing month, and perfectly justifies its valuation at 16 times sales and 26 times earnings, given the massive digital payments tailwinds in its favor. Visa rewards shareholders generously with $5 billion in dividends and buybacks during the quarter alone, made possible by its $20 billion treasure trove, just $21 billion in debt, and $21 billion in cash flow.

The stock hit a new all-time high Wednesday at $263. Our Target is $265 and We Would Never Sell Visa. The Target is hereby raised to $295. This $530 billion market company is heading higher, of that there is no doubt. We added the stock seven years ago in 2016 at $70. How are we doing? And where do you think the stock will be in another seven years? Let’s put it this way: If you don’t have any shares, get some in your portfolio!

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Eli Lilly (LLY: $572, down 4%)
Healthcare Portfolio

Pharmaceuticals giant Eli Lilly released its third quarter results recently, reporting $9.5 billion in revenues, up 37% YoY, compared to $7.3 billion a year ago. The company posted a profit of $3.1 billion, or $3.39 per share, against $1.8 billion, or $1.98. It was, however, hit with a $3.0 billion charge from acquiring in-process research and development during the quarter.

During the quarter, the company saw strong growth in its metastatic breast cancer drug, Verzanio, with sales hitting $1 billion, up 68% YoY, and the diabetic medication, Jardiance at $700 million, up 22% YoY. However, other blockbuster products such as Trulicity fell a bit, with a 10% drop in sales YoY, largely owing to the changes to estimates for rebates and discounts during the period in question.

The big news for the company and shareholders during the quarter is the US and EU approval for its anti-obesity drug Zepbound, with results showing a reduction in major cardiovascular events, in addition to substantial weight loss benefits. The drug will be available by the end of this month. Goldman Sachs expects this class of drugs to bring in $150 billion in additional revenues through 2030.

Eli saw strong progress on the pipeline front, with FDA approval for Omvoh, to treat adults with ulcerative colitis. These developments couldn’t have come at a better time, considering that it is set to lose exclusivity to Trulicity in the US by 2027, eating away a good chunk of its revenues.

Eli Lilly had a banner year for its pipeline in 2023. Here's a breakdown of the highlights:

Regulatory Approvals:

• Donanemab (Lecanemab): This Alzheimer's disease treatment received FDA approval in July, becoming the first anti-amyloid therapy to reach the market. This was a major milestone for Lilly and a promising development for Alzheimer's patients.
• Mirikizumab: This IL-23 inhibitor was approved in September for plaque psoriasis, offering a new option for patients.
• Lebrikizumab: This IL-13 inhibitor was approved in the US and EU in December for adults and adolescents with severe nasal polyposis, offering relief from a debilitating condition.
• Tirzepatide (Zepbound): This dual GLP-1 and GIP receptor agonist completed positive FDA approval came in November. It appears that it will become a blockbuster drug for weight management.

Late-Stage Pipeline Advancement:

• Pirtobrutinib: This BTK inhibitor demonstrated promising efficacy in Phase 3 trials for mantle cell lymphoma and chronic lymphocytic leukemia. On December 1, 2023, the Food and Drug Administration granted accelerated approval to pirtobrutinib for adults with chronic lymphocytic leukemia or small lymphocytic lymphoma.

Eli Lilly has done remarkably well this year, with the stock posting a YTD rally of 57%, and while its valuations might seem expensive at 16 times sales and 46 times earnings, they are perfectly justified given the potential of its new drugs in the obesity niche. The company ended the quarter with a strong balance sheet, comprising $2.6 billion in cash, $20 billion in debt, and $5.7 billion in cash flow. Our Target is $665 and We Would Not Sell Eli Lilly. We added the company at $69 in 2016. We like this company!

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ServiceNow (NOW: $698, flat)
High Technology Portfolio

Enterprise cloud computing giant ServiceNow released its third quarter results recently, reporting $2.3 billion in revenues, up 25% YoY, compared to $1.8 billion a year earlier. The company posted a profit of $240 million, or $1.18 per share, against $150 million, or $0.74, with a beat on estimates at the top and bottom lines, coupled with strong guidance for the full year resulting in an extended rally for the stock, rallying from $530 to its present level at $700. The stock hit a new all-time high this week at $720.

Subscription revenues led the way with $2.2 billion in revenues. Current remaining performance obligations stood at $7.4 billion, up 24% YoY, which is set to be realized over the next 12 months, largely the result of large multi-million dollar, multi-year commitments from leading organizations across the world. During the third quarter alone, the company inked 83 new deals with annual contract values over $1 million, an increase of 20% YoY. It currently boasts a total of 1,800 customers with annual spends in excess of $1 million, and 50 customers spending more than $20 million, an increase of 58% YoY. A few new additions included the US Air Force, Cleveland Clinic, and one of the world’s largest automakers.

As always, the company continues to go all-out when it comes to growing its base and executing plans. So far this year, it has unveiled 5,000 new capabilities, including a wide range of generative AI features to help its customers unlock value. The company has since embedded AI across all workflows, with text summarization, chat, and search being a few of the many new features available to customers.

The company is slowly, but surely turning its platform into a must-have for enterprise systems and workflows. If not for its extensive platform and features, the partnerships and integrations it has built over the years will create substantial moats to stave off competitors making it a strong value creator going forward. It ended the quarter with $4.1 billion in cash, $2.3 billion in debt, and $3 billion in cash flow.

This is no small company, clocking in at $143 billion in market cap. It’s certainly not cheap when you look at the P/S ratio – Price to Sales. 6-10 is high. ServiceNow checks in at 143/8.5 which equals 17. Revenues for the past few years were $4.5 billion, $5.9 billion, $7.2 billion in 2022, and what looks like $8.5 billion in 2023. If the company can hit $10 billion in 2024, that would bring the P/S ratio down to 14 – high but not killer high. Our Target is $650 and our Sell Price is $500. The stock blew through our Target in mid-November. Let’s do this: We are raising our Target to $800 and raising our Sell Price to $650. This is a high-flyer for sure. We love the company and believe they will continue to go places in the future. They are showing good growth in revenues, profits are good, but not stellar. But if the market turns sour, high flyers tend to fly lower, many times quickly. Watch your investment here closely.

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Occidental Petroleum (OXY: $59, up 4%)
Energy Portfolio

Hydrocarbon exploration company Occidental Petroleum released its third quarter results recently, reporting $7.4 billion in revenues, down 22% YoY, compared to $9.5 billion a year ago. It posted a profit of $1.1 billion, or $1.18 per share, down from $2.5 billion, or $2.44, but posted a beat on estimates on the top and bottom lines, coupled with a rise in its full-year guidance figures.

The drop in revenues and profits during the quarter is largely in line with the broader energy industry, which has been hit hard by falling global oil and gas prices after a run-up last year. The company, however, produced 1.22 million barrels of oil equivalent per day, above its estimates in August.

Its chemicals business, OxyChem, posted a profit of $370 million, down slightly from $440 million the prior quarter, owing to falling margins. The marketing segment posted a loss of $130 million, as against a loss of $30 million the prior quarter, as midstream margins started to get squeezed amidst falling global demand and prices.

During the quarter, the company announced that it wished to acquire the oil and gas producer CrownRock, in a deal estimated to be worth $12 billion. This will add 170,000 barrels of oil production per day, and 1,700 more undeveloped locations, with the potential to create substantial cost synergies going forward. Occidental is now diversifying into carbon capture, even as its fossil fuel business continues to go strong. Carbon capture has been in the news recently, especially at the Climate Change Conference that just ended in Dubai. Oxy is one of the first to invest in this potential big business.

The stock is down 4% YTD, trading at under 2 times sales and 12 times earnings, offering immense value to investors. It has made great use of the cash it generates each quarter, with $1.5 billion in YTD preferred stock redemptions, and it bought back $340 million of Berkshire Hathaway's preferred shares, bringing redemptions this year to 15% of the initial $10 billion investment by Warren Buffett's firm that was used by Occidental to fund its acquisition of Anadarko Petroleum in 2019. It has rapidly reduced debt, all the while continuing the $600 million in stock repurchases. Our Target is $90 and our Sell Price of $61 is lowered today to $50. We would be buyers of Oxy here at $59, rather than sellers. If Warren likes it, we like it. Not always, but certainly here. We can see Berkshire making an offer for the whole company at something north of $75 a share sometime in 2024 or 2025. This could be one of Warren’s last large legacy moves.

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C3.ai (AI: $31, up 10%)
Early Stage Portfolio

Enterprise AI startup C3.ai released its second quarter results last week, reporting $73 million in revenues, up 17% YoY, compared to $62 million a year ago. The company posted a loss of $15 million, or $0.13 per share, against a loss of $12 million, or $0.11, with a beat on earnings estimates, and a miss on the top line figures, despite which the stock posted a 15% rally following the results. The company’s subscription revenues now constitute 91% of total revenues. During the quarter, the company added a string of new marquee customers to its roster. This includes the likes of GlaxoSmithKline, Indorama, and First Business Bank. It expanded its agreements with Nucor, Hewlett Packard, Roche, and Con Edison, among others.

C3’s federal bookings continue to remain upbeat, with 20 new agreements signed, representing half of total new bookings during the quarter. It further expanded its agreements with Federal agencies such as the US Navy, the Office of The Director of National Intelligence, the Defense Logistics Agency, and the Department of Health & Human Services, among others.

In the sprawling landscape of digital innovation, C3.AI stands out as a beacon of practical intelligence. They haven't gone chasing the latest Artificial Intelligence whims; instead, they've chosen to forge a path through the dense jungle of business complexities, armed with the tools of artificial intuition. Their mission? To equip organizations with weapons, not of war but of optimization, growth, and informed decision-making. For example, oil and gas companies can now monitor the health of their assets with hawk-like precision, while manufacturers can produce optimized production lines. C3.AI software helps banks fight fraud by using algorithms to spot early warning signs, preventing major problems. The company focuses on solving specific industry problems, making its solutions relevant and accurate. Plus, their platform is easy to use, even for people without an AI background. C3.AI is making AI accessible and practical for everyday businesses, paving the way for a future where AI is a real tool for success.

Growth has slowed down in recent quarters largely owing to its pivot to a consumption-based pricing strategy, where it plans to implement a pricing model based on vCPU/Hour*, which it believes will be the standard for cloud software pricing going forward. This model brings C3’s solutions within the purview of small businesses and startups, as opposed to large government agencies and enterprises like it is today.

* Virtual central processing unit - A pricing model that refers to a cloud computing billing system where you pay for the vCPU resources you use per hour.

C3’s growing partner ecosystem has been its biggest achievement so far this year, having closed 40 agreements with the help of its partners such as AWS, Baker Hughes, Booz Allen, Google Cloud, and Microsoft. Despite the volatility, the stock is close to a triple YTD, and while profitability remains elusive, the company is well capitalized, with $760 million in cash, and no debt. Our Target is $50 and our Sell Price is $24.

Don’t forget how volatile this stock can be. The market cap is only $3.7 billion, so an influx of buy or sell orders can move this stock by 3-5 points a day and more. Be very careful with this speculative stock. It’s not profitable and Wall Street hasn’t liked non-profitable stocks for the last two years. (It never really has liked them, but has tolerated them in various periods over the past decades.) However, any sustained downward movement in the overall market will knock this stock for a loop. We can see it below $20 before you know what hit you. Be careful.

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Energy Transfer (ET: $13.71, up 3%. Yield=9.1%)
Energy Portfolio

Midstream giant Energy Transfer Partners reported its third quarter results recently, posting $21 billion in revenues, down 10% YoY, compared to $23 billion a year ago. Profits hit $470 million, or $0.15 per share, down from $900 million, or $0.29, owing to the sharp drop in the prices of natural gas and natural gas liquids over the past year and a half. The company hit record natural gas transportation, fractionation, and export volumes, up by 14%, 9%, and 20% on a YoY basis, respectively. Its intrastate and interstate transportation volumes were up by 2% and 15%, respectively, followed by crude transportation and terminal volumes posting growth of 23% and 15%, another significant record for the firm.

Energy Transfer is a midstream energy giant playing a crucial role in moving natural gas and natural gas liquids (NGLs) across North America.

What They Do:

• Transportation: ET owns and operates an extensive network of pipelines, spanning nearly 90,000 miles, that transport natural gas, natural gas liquids, and crude oil to processing facilities, storage areas, and ultimately, end-users.
• Processing: Through its network of processing facilities, (80 gas processing plants in Texas, Louisiana, Pennsylvania, Oklahoma, and Wyoming, among others, Energy Transfer removes impurities and separates NGLs from raw natural gas, unlocking their commercial value.
• Storage: ET boasts massive storage capacity for both natural gas and NGLs, enabling companies to manage supply fluctuations and optimize delivery.
• Marketing: ET acts as a matchmaker, connecting producers of natural gas and NGLs with buyers at the best price, earning fees for facilitating these transactions.

What They Own:

• NGL Fractionators: ET owns 8 fractionators with a total capacity of approximately 1.15 million barrels per day (mbpd).
  • Some of their facilities combine fractionation and storage, so the total number of fractionation units might be slightly higher.
• NGL Fractionation & Storage Hubs: The exact number isn't publicly available, but:
  • They mention "several" NGL fractionation and storage hubs in their project highlights.
  • Given their focus on integrated facilities, a significant portion of their 8 fractionators may also function as hubs with storage capabilities.
• Export Terminals: They currently operate 3 export terminals:
  • Nederland Terminal in Texas
  • Marcus Hook Terminal in Pennsylvania
  • AltaGas Liquids terminal in British Columbia, Canada

Energy Transfer remains resilient to challenging times largely owing to its extensive diversification and strong footprint across the midstream segment within the US. It remains committed to growing along the same lines, with $2 billion a year earmarked for capital spending, with 40% allocated to midstream projects, and the rest aimed at a wide variety of NGL, refined products, and interstate production projects.

The energy sector continues to see substantial headwinds from climate change activism, but Energy Transfer Partners remains insulated in this regard, owing to its focus on natural gas, as opposed to crude oil. Natural gas and natural gas liquids are believed to be a strong ally in the fight against climate change and are expected to play a key role in the global transition away from fossil fuels over the coming years.

The stock is up 18% YTD, and is still very attractively priced at a little over 0.50 times sales and 8 times earnings, all the while offering enticing dividend yields of 9.1%. In August, ET announced a $7 billion merger with Crestwood Equity Partners in a bid to take advantage of substantial cost-saving synergies*. The company has a mammoth $9.6 billion in cash flow. Our Target is $15 and our Sell Price is $12. Energy Transfer is no small company, clocking in at $46 billion. We believe in the Energy business in the United States, especially natural gas and liquids. ET keeps these fluids flowing 24 hours a day, 365 days a year. We can see this firm at $17 in a few years, all the while paying its fabulous 9% dividend.

* Crestwood Equity Partners includes gathering and processing assets located in the Williston, Delaware, and Powder River basins, including approximately 2.0 billion cubic feet per day of gas gathering capacity, 1.4 billion cubic feet per day of gas processing capacity, and 340 thousand barrels per day of crude gathering capacity. When consummated, this transaction would extend Energy Transfer’s position in the value chain deeper into the Williston and Delaware basins while also providing entry into the Powder River basin. These assets are expected to complement Energy Transfer’s downstream fractionation capacity at Mont Belvieu, as well as its hydrocarbon export capabilities from both its Nederland Terminal in Texas and the Marcus Hook Terminal in Philadelphia, Pennsylvania.

This transaction is also expected to provide benefits to Energy Transfer’s NGL & Refined Products and Crude Oil businesses with the addition of strategically located storage and terminal assets, including approximately 10 million barrels of storage capacity, as well as trucking and rail terminals. These systems are anchored by predominantly investment-grade producer customers with firm, long-term contracts, and significant acreage dedications.

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The Bull Market High Yield Investor 

By now you know that everyone at the Fed who votes on monetary policy thinks interest rates are going down at least 0.5 percentage point in the coming year and some anticipate double that level of easing. But Jay Powell said two more things that should guide every investor’s strategic outlook. First, Powell “welcomes the progress” on inflation. That’s a crucial attitude if you’re committed to being invested throughout your life.

He isn’t banking on inflation continuing to drop at any particular rate or to any particular level across any particular timeline. But he isn’t asking a lot of questions about the trailing numbers either, hoping to somehow reveal a hidden problem. All the most powerful person in the global economy is doing is accepting the good data alongside the bad. Life is like that. There will be good numbers and bad ones. You can’t explain the bad beats away. Reality is reality. However, that also means you can’t close yourself off to the good beats when they hit.

As human beings, most of us fear the pain and try to avoid it. Go too far in that direction and you end up closing yourself off to the progress, and to the opportunities life also provides. When you’re closed off to the opportunities, you’re not an investor. At best, you’re watching somebody else’s experience and refusing to participate because you have a feeling it’s all a horror movie in the long run. If that’s your world, we can’t help you. Protect what you have as well as you can because you’re probably not open to the possibility of taking a calculated risk that pays off to put you ahead of where you are right now.

That’s not our world. We're invested. And it’s not Powell’s world either. When he sees progress, he doesn’t nitpick it into oblivion by interrogating how long it lasts or even if it’s real. He accepts it. Embraces it. “Welcomes” it when it comes. On Wall Street, we make money when it’s flowing. We've watched Jay Powell for years and he believes in calculated risk, which is another way of saying he’s motivated by a form of game theory. When making a move gives him a reasonable opportunity to change the game board in his favor, he’ll make the move. Otherwise, he’s content to conserve his resources for a better opening.

Of course, that move needs to make a real impact. It has to be meaningful. We’re lucky on Wall Street because our moves all have money attached and money is a number. If the move doesn’t move the money more than you’d get in the bond market, it isn’t worth making. But then there’s that second insight Powell made in the press conference. “There’s little basis for thinking the economy is in a recession now.” Every word there matters. He’s not blindly optimistic. He knows that you’re rarely more than 3 years away from the next recession and rarely more than 5 years from that cyclical moment of truth.

As he told the reporter, there’s always a chance that a recession is mere months from materializing. They can even come from thin air like the one in 2020 when the economy locked down hard and fast. However, you can’t plan for thin-air scenarios like a global pandemic. Investors and other human beings need to extrapolate from current conditions to shape our expectations about the future. Does the world look good or bad right now? Is it getting better or worse? At what rate?

A recession is nothing but a deterioration in economic conditions big enough to affect a broad segment of the population and lasting at least 5-6 months. That’s it. It doesn’t mean mass layoffs, bank crashes, bear markets, a bent yield curve or profound suffering. And the logical correlate of that is that mass layoffs, bank crashes, the yield curve, the market and profound suffering do not necessarily line up with every recession. They often come together but the causal relationship is more complicated. Bear markets and the yield curve tend to precede a recession. The Fed has a lot of power over the yield curve and markets fear the Fed.

But right now, nobody in the Fed expects GDP to decline in the coming year. Growth will slow to somewhere above 1 percent and below 2 percent, but that’s far from the end of the world. We’ve muddled through with less in the past. It doesn’t mean active economic destruction; or wealth destruction. At worst, the people who vote at the Fed think unemployment will edge up to 4.2% next year. Again, not the apocalypse. Closer to “normal” historically. Powell used the word “normalizing” a lot in that press conference. Going back to “normal” only feels awful when you’re addicted to abnormal, if not completely unsustainable conditions. And as far as he can see, there’s “little basis” for thinking things are all that terrible right now. He’s approaching this as an economist and Wall Street insider, not as a private person.

This economy can feel miserable. We get it. It’s been a long and exhausting couple of years. We’re all working harder just to keep up with inflation. But the numbers don’t support that misery. When that happens, economists and Wall Street insiders acknowledge their feeling but go with the numbers. We trade on numbers. Our feelings are our own. Powell doesn’t see much basis for thinking the economy is in a recession right “now,” here in the present where we're writing this and you’re reading it.

This is the time that matters. The past is dead. We can’t trade it or go back in any way to change it. The future is nebulous. None of us can predict it. All we can do is extrapolate on the conditions we see in the present. If they continue, the future will look like the present. If they change, the future will change in that direction. Powell and his cronies at the Fed don’t see the present as that bad. Wall Street agrees. The Dow and the Nasdaq (it's close) are hitting record highs. This is the best those indices have done in all of history.

Is this as good as it gets? The Fed thinks things get a little better next year. In that scenario, we’ve already lived through the worst. We welcome the progress. We hope you do as well. And with that in mind, we need to cut a stock that has been defensive one without giving us much progress. Time to let it go in order to focus on other recommendations that can actually embrace the gift the future provides.

Ventas (VTR: $49, up 6%)
REMOVING COVERAGE

We added Ventas to our portfolio in 2016 at $60 a share. On paper, this is a perfect stock to hold, as the company is one of the largest owners and operators of healthcare facilities across the world, being largely recession-proof with extensive diversification across locations, industries, and geographic locations. In addition to this, it has broad multi-decade-long secular tailwinds in its favor, with the potential to create substantial value.

Yet, since we added this REIT seven years ago, revenues have grown at a snail's pace of just 2.6% annually, and the stock languished. Despite being a high-quality company, it has consistently been dealt with a tough set of cards in recent years, and while it might seem rational to wait for a while longer as it finds its post-COVID heels, we are pretty done with this stock. We've cashed $17 in dividends so we haven't done badly . . . but there are many other good places for your capital.

Rithm Capital (RITM: $10.87, up 4%. Yield=9.1%)
High Yield Portfolio

Rithm Capital is a highly diversified asset management company, active in lending, financing, real estate investments, and more. The third quarter results, saw $1.1 billion in revenues, up 20% YoY, compared to $910 million a year ago. The company posted a profit of $280 million, or $0.58 per share, against $300 million, or $0.62, with a beat on consensus estimates at the top and bottom lines.

Rithm Capital is highly differentiated from other mortgage REITs and BDCs with its business diversified across various lines of business including but not limited to mortgage lending, consumer lending, mortgage servicing, single-family rentals, and with its recent acquisition, wealth management, creating a broadly covered and well-hedged portfolio for all market conditions.

During periods of higher interest rates such as the present, when originations witness a slowdown, the company’s $600 billion mortgage servicing rights portfolio comes to its aid, along with its single-family rentals with high interest rates making home ownership harder. During the quarter, its NewRez operating business generated funded originations to the tune of $11 billion, down from $13 billion a year ago.

The company completed its merger with Sculptor Capital Management in November, absorbing its $33 billion of assets under management, as it continues its foray into investment management, effectively putting it on the same lines as PE giants such as Blackstone, although it is nowhere as big just yet. Last year it acquired a 50% stake in Senlac Ridge Partners (now Greenbarn Investment Group), an investment management firm with a focus on commercial real estate, to expand its presence in this lucrative space.

The stock is up by a stellar 31% YTD, while still trading at a little over 2 times sales and 6 times earnings, and offering an annualized yield of 9.1%. Despite the run-up in recent months, it trades at a 12% discount to book value.  Our Target is $13 and our Sell Price of $8.50 is a bit low, so we are raising it to $9.50. We are very high on Rithm Capital. Their commitment to innovation and recent acquisition spree hint at major expansion plans. CEO Michael Nierenberg's vision is clear – he wants to see this relatively small company ($5 billion market cap) become a much bigger player. While predicting the future is always tricky, reaching twice its current size in two years and crossing the $20 billion mark by 2030 are strong possibilities.

Nuveen AMT-Free Municipal Credit Income Fund (NVG: $11.97, up 3%. Yield=5.1% tax free, the equivalent of 7.8% taxable)
High Yield Portfolio

The Nuveen AMT-Free Income Fund has posted a remarkable rally since we last discussed the fund a couple of months ago. This rally isn’t surprising considering the strong favorable economic data emerging from across quarters, and the Fed finally pivoting from its hawkish position on interest rates, which means debt investors can finally see some value following months of testing newer lows.

While we may see some rate cuts over the coming months, interest rates in general will remain higher for longer. This leaves muni bonds at a rather attractive position, with less risk of value erosion owing to rising interest rates, while at the same time offering equity-like yields, and little-to-no downside risks. This will prompt steady inflows into municipal bonds and funds over the upcoming few months.

For the first time in years, there is compelling value to be found across the muni bond spectrum, as investors want to lock in on attractive yields by reallocating funds from elsewhere. Given that muni bonds are next to only treasuries when considering the risk of default, they are much better positioned when compared to corporate bonds which still have to deal with many more macro uncertainties.

We’ve seen a nice 20% rally in the past two months and the stock is now just down by 3% YTD, and continuing to trade at a 12% discount to book value. As we’ve mentioned many times in the past, for long-term, conservative investors all of this is just noise. If you’re looking for tax-free yields of 5.1% and a default rate that is less than 0.08%, there are no better funds than the Nuveen AMT-Free Municipal Credit Income Fund. Our Target is $16 and our Sell Price is $11.

Good Investing,

Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998