Multiples, Expanding Multiples and the Energy Spectrum (KOL)

We want to take a minute to discuss a topic we’ve broached several times over the past few years and again bears repeating.

 

The idea is de rigeur on Wall Street, but not so much beyond those precincts.

 

It’s called ‘multiple expansion’.

 

But you may as well refer to it as monetary sorcery.

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Consider an example –

 

Caterpillar stock (NYSE:CAT) is trading at $10 in year X and has earnings of a dollar a share.  Its Price/Earnings ratio is therefore 10.

 

Then, in years X+1, X+2, and X+3, the company earns… the exact same amount!  No change at all.  If it’s still trading at $10, it will carry the selfsame earnings multiple of 10.

 

Fine and dandy.

 

But what should happen to the price of a stock whose earnings remain, shall we say ‘stagnant’, for four years running!?

 

According to you and I, perhaps the shares should fall, even slightly, to account for the company’s inability to grow its profits.

 

But not according to Wall Street.

 

No, no.  Wall Street has a different calculus, the most important part of which relates to its own quarterly earnings (and bonuses).

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What Wall Street therefore does, is to publish ‘research’ on Caterpillar that it sends to all its brokers and clients.  And in that ‘research’ it explains why CAT shares are worthy of a ‘forward earnings multiple (isn’t that a great one?!) of 14.  It justifies this, of course, by calling out the competition and all the problems they’re having, explaining all of CAT’s new money-making initiatives, discussing their share buyback program and any other sleight-of-hand they can conjure up, and before you know it, the stock is, indeed, trading at $14.

 

Wonder of wonders.

 

What’s Good for the Goose…

 

The broad market, too, gets a similarly puffed up forward multiple, based on the wonderful work of its constituent companies, and hey! ho! whaddaya know, Wall Street has created a bull market in stocks and plenty of commissions for all the major brokerages, to boot.

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But earnings haven’t budged.

 

Needless to say, the whole effort is –

 

  • accepted wholeheartedly by the brokerages, media and investing public, and
  • is outright fraudulent.

 

There is no growth.

 

When indicators like global trade, electricity consumption and rail traffic (to name just a few) are failing to grow, there’s genuine cause for worry.  And until those numbers see an increase (along with real earnings growth), it’s dishonest in the extreme to claim that the picture is pretty, multiples can be expanded, and the Fed will eventually arrive to save the day, regardless the crisis.

 

But…

 

It’s not a lie to claim that the stock market will continue to rise.

 

Not at all.

 

Wall Street can resort to every sort of shenanigan and tomfoolery it knows, and the game can go on for years, before momentum finally stalls and the downdraft commences.

 

In the meantime, reality is reality.

 

Prices are climbing.

___________________________________________________________________

 

The move likely has a ways to carry.  It’s not real, of course, in the sense that it’s not honest; it’s not driven by anything fundamental.  But it’s going higher all the same.  And if our job is to make money in this arena, then why should we care what’s underpinning it?

 

Where’s your integrity, Hugh?

 

Forgive the analogy, but a person involved in an abusive relationship, who wants out, but hasn’t yet mustered the strength or wherewithal or courage to leave, should not be faulted for continuing to eat at the table of the abuser who feeds him/her.

 

Right?

 

The day will come, of course, when a final exit occurs.  But until then, should we starve because the chef is a no-good, dirty son-of-a-bouche?

 

Hell, no!  Our forks and knives are out, we’re hungry, and the meat is being served.

 

Tapping the Energy Spectrum

 

With that in mind, we’re going to look at the energy sector for this week’s trade, a corner of the market that has seen tremendous technical developments of late.  We’re talking about all the subsectors, including oil, gas and coal.

 

And we’re going to highlight a few of those technicals now, in order to better illustrate our trade for the week.

 

Let’s start with oil, as represented by the United States Oil Fund ETF (NYSE:USO), a proxy for NYMEX crude.

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For the bulls, it’s all good news here.

 

Following a breakout from a descending wedge (always a bullish pattern, in red), crude oil is up over 10%, and climbing.

 

Supported by a substantial surge in volume (double the daily average, in yellow), it’s clear that oil still has a distance to run.  She’s overtaken three of her four salient moving averages, and, as of three trading sessions ago, RSI and MACD are both trending above their waterlines (in green).

 

Or, to put it another way, oil’s got a future.

 

So, too, with the sister goo.

 

But if crude oil looks good, natural gas, as represented by the United States Natural Gas Fund ETF (NYSE:UNG) looks even better.

 

Take a look –

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Natural Gas suffered a ghastly skydiving accident over the last several years and looks only now to be recovering.  The weekly chart looks even better than the daily we’ve reproduced above.

 

And what’s good here?

 

  1. First, the portly, rounded bottom that has formed over the last three months (in red) is a reliable – and downright attractive – bullish indicator that speaks to the strength of the coming move. Some may also see a cup and handle formation (including the blue).  Either way, the signs are bullish.
  2. The breakout above long term resistance at UNG $9.00 is also significant, as it marks the best price showing for the shares going back to November of 2015.
  3. RSI and MACD have been reliably bullish for nearly eight weeks.

 

All told, we see little in the way of UNG rising to its long term moving average at $10 in the very near term.  As to what occurs thereafter, we’ll have to reassess the situation once we arrive there.

 

Today’s Trade

 

It’s to the coal sector we’re turning for our trade, because coal, as a group, has outperformed the rest of the sector for some time.

 

Have a look at the VanEck Vectors Coal ETF (NYSE:KOL) for the last six months –

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The coal sector is so hot it’s overdone.  RSI is above the overbought 80 level after a 66% rise in less than five months.

 

Things are about to cool down.

 

Our trade this week takes advantage of that.

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With kind regards,

 

Hugh L. O’Haynew

See what people are saying...

  1. Chaz Zweber

    hmmm, TD account didnt like this trade? it said prohibited positiion. any thoughts?

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