Primary Risks: The market is being driven primarily by three variables: global trade/growth numbers, the productivity of US/China trade talks, and Fed actions. We believe the market (especially in the US) is already priced, assuming these factors will have neutral to positive outcomes in the near-term. Neutral to negative outcomes on a factor may pressure valuations.
Primary Supports: US households are very healthy with rising real incomes and far lower debt and default levels for what you might expect this far into an expansion. This spending has helped offset falling business investment. Also, despite fears that 2019 earnings would show weakness, they have so far been resilient and surpassed the 2018 record level. Finally, the gaping disparity in valuations between stocks (5.3% Op.Earn/4.7% A.R.Earn Yields) and bonds (1.68% Yield) will likely keep typical market downturns from becoming large magnitude (-20% to -50%) declines.
2019 Outlook: The market is up about 15% YTD, but most of this return is simply correcting the overdone downturn in the 4th quarter. So, while it is likely that the bulk of returns in 2019 have already been captured, it is not at all unreasonable that, with current supports, investors should capture additional returns during the remainder of the year. We want to remain invested broadly across equity markets but will pare back equities if portfolios are too underweight to cash and fixed income assets. Because of the risks outlined above, we expect volatility to increase from its levels earlier this year.
Exencial attempts to identify companies with open-ended growth opportunities, distinct competitive advantages, and reasonable valuations. These companies grow earnings meaningfully and have excellent management teams. At a time when the economy may be slowing and the market is questioning whether valuations are justified, we believe investors should hold high-quality companies that have some margin for safety in their valuations.
Delta Airlines (DAL):
- The airline industry has better economics than ever before. Rapid consolidations and bankruptcies have increased market share of the main U.S companies. Now the top 4 US airlines control over 70% of the market share and have the strongest free cash flow in decades.
- The travel industry is growing faster than GDP. The number of travelers is expected to increase by over 50% in the next decade.
- We believe Delta is the best run airline in the world. It Is transforming the travel experience with large investments in technology, such as biometrics at the airports (e.g., no tickets and passports necessary). Delta also has increased passenger options such as pre-ordered meals before boarding the flight and free Wi-Fi. The stock sells at 9 P/E next year’s estimated earnings.
- Teradyne controls over 60% market share of collaborative robots. These robots work next to humans to help them in light- duty industrial applications like welding, as well as other applications in health care and university classes for teaching robotics.
- We are at the beginning stages of a robotics revolution. Companies around the world are starting to use these robots to increase productivity. These robots are easier to program and more cost efficient compared to other robots in the market.
- Teradyne is the number one player in testing for microchips that go into Internet of Thing products (e.g., smart speakers, smart appliances, etc.) and has a strong leadership in 5G cellular testing. The stock sells at 16 P/E next year’s estimates.
- Gartner is the world’s leading information technology research and advisory company. It helps companies make better decisions about technology, marketing, and HR.
- Every company is becoming a technology company. In this period of heavy disruption, companies look for Gartner’s expertise to help them navigate this environment.
- Gartner’s revenue stream and cash flow are very stable even in recessionary periods—companies experience faster disruption during a recession, which means steady business for Gartner. For all these reasons, Gartner deserves a higher P/E. We think at the current P/E of 28 is reasonable and undervalues the future growth of this company.
Disclosures: Yepez & Exencial Wealth Advisors owns DAL, TER & IT for clients.