Motley Fool Hidden Gems Investing - Cybersecurity, Heavy Equipment, Social Media

Episode Date: August 2, 2022

What do Caterpillar, Arista Networks, and Pinterest have in common? 2nd-quarter earnings reports! (0:25) Bill Mann discusses: - Global supply chain issues (understandably) affecting Caterpillar's results - How dividend-seeking investors should think about Caterpillar - Stellar results from Arista Networks and its longtime CEO Jayshree Ullal - Pinterest shares popping on user numbers and the backing of activist investor Elliott Management Sign up for Stock Advisor at http://fool.com/foolfest and you’ll get a complimentary digital pass to our FoolFest 2022, our 2-day investing conference! (13:51) Alison Southwick and Robert Brokamp talk about the indicators commonly associated with recessions and which ones they're watching. Stocks discussed on the show: CAT, ANET, PINS, TWTR Host: Chris Hill Guests: Jason Moser, Alison Southwick, Robert Brokamp Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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BetMGM operates pursuant to an operating agreement with iGaming Ontario. We've got the latest in heavy equipment, cybersecurity, and social media. Motley Fool Money starts now. I'm Chris Hill, joined in studio by Motley Fool Senior Analyst Bill Mann. How sweet does that sound? It certainly feels good to say. Not the Bill Mann part, but the in-studio part. It's pretty darn sweet, I got to tell you. Let's start with Caterpillar, shall we? Second quarter revenue lower than Wall Street was expecting due to supply chain issues and the company exiting Russia. This can't be a surprise, right?

That was overwhelmingly my thought when I was reading through how Caterpillar did. And it's not terrible. The stock's down 3%, about what you would expect for a company of their size and scope. But I just thought, we're not really surprised by any of this, are we? We really shouldn't be. Their biggest miss came in the construction industry, which you could easily see why that would be the case. As you've said, there are supply chain issues. They've had a huge issue. One of Caterpillar's largest markets is China. Things have ground to a stop in China in terms of housing construction, in terms of infrastructure construction. I guess, to me, the surprise is that the consensus was as high as it was. This was a great quarter

Caterpillar given that backdrop? Shares are outperforming the S&P 500 year-to-date, which is to say, it's down, but just not down as much as the overall market. I think of Caterpillar as being in that category of, this is the category of stocks that are big, blue-chip, they pay a dividend, they're not going to go anywhere. Am I missing something? or is that how people should think about a company like Caterpillar? Like, hey, if you're looking to build out the dividend part of your portfolio, kick the tires on this one. Was that a joke? I didn't mean it to be. I really didn't. Well done, though. Yes. Caterpillar is one of those companies that should behave

about at the same level as global GDP growth. Maybe a little bit ahead of it. It's a fine company. there are not that many competitors in most of Caterpillar's businesses at its size. But because it is so defined by how the economy is going, if the economy is not going well, for example, now their cost structures are really not going very well for them. As I said earlier, China is not going very well for them. They have supply chain issues. And so, yes, I mean, it is a great company to own. You are very unlikely to find yourself waking up one morning and Caterpillar has rugged you. But at the same time, it's not going to be a massive, massive grower. Thank you for using rug as a verb. Arista Networks, the cloud networking

cybersecurity company, posted second quarter profits and revenue that were higher than expected. They had upbeat guidance for the current quarter, and yet shares are flat. Are we not entertained? We should be entertained. In fact, it started this morning up about 6.5%. So, by the time we actually end today, the trading day, it could be anywhere. It was a great quarter for them. I mean, you could see why. Arista Networks is an absolutely necessary component in cloud computing, in enterprise. They've grown very, very quickly, 49% revenue growth, which was described as a little oasis of positivity in a market that doesn't show very much of it. They also talked about a supply chain environment

that is troubling for them. Their quarter may have even been better, but their CEO, Jayshree Ullal is one of the best in America. Full stop. She is absolutely fantastic in managing their business, at not getting too far ahead of their skis. This is a company that's running on as many cylinders as you can be in the current environment. Which, if you step back from Arista Networks, I feel like, I don't want to say every company is to be able to say this, but I feel like there are going to be a lot of companies this earnings season that we're going to have that to say about them. Like, hey, this was good. If they're doing this level of performance in this environment, the bull case is obviously, gosh, when things

get better on a macro level, they're just going to tear the roof off of things. Have you ever seen one of those word clouds? I think if you do a word cloud for earnings reports this time, the one that's going to be at the very center, oh, gosh, it's two words, not one. One is supply chains. Supply chains is one that nearly every company will be able to credibly point to and say that this has been an impact on how they have done over the last quarter. Some of them will be using that as an excuse. But in a lot of cases, it makes a ton of sense. Yes, for Arista to have come out and have been, as I said, this little oasis of positivity, I think that it's very credible to say that in a normal

operating environment, when have we had one of those, but in a normal operating environment, their results would have been even better. Jayshree Lal, as Bill mentioned, the CEO of Arista Networks. She has been a guest of ours at Motley Fool investing conferences in the past. She is not going to be at this year's FoolFest, which is our annual investing conference. It's a two-day event on August 29th and 30th. There will be breakout sessions featuring different investing strategies. We have a great lineup of speakers, including TREX CEO Brian Fairbanks, Motley Fool co-founder David Gardner, our friend Morgan Housel. Michael Mauboussin. Yes!

Investor extraordinaire Michael Mauboussin, who you're going to be interviewing on the main stage. I will. And I can't wait. I'm glad that you actually got around to saying who was going to be there as opposed to who wasn't. That's not good marketing. I'm doing my best here. I'm doing my best. I cannot wait. Yeah, it's going to be great. FoolFest is free for Motley Fool members, so if you are not yet a member, that's easy to remedy. You can sign up for our Stock Advisor service and get a complimentary digital pass to the event. Just go to fool.com slash FoolFest. All one word for the details.

I'll put the link in the show notes. That's fool.com slash FoolFest. The stock of the day is Pinterest. I don't even remember the last time I said that. Second quarter results weren't great. Guidance wasn't great. but shares are up more than 10% today after Pinterest's user numbers showed some promise. Activist investor Elliott Management confirmed that it is the company's biggest shareholder and has, and I'm quoting here, conviction in the value creation opportunity that it sees. Which I think is a fancy way of saying... It's cheap! The stock is cheap. When these people get their monetization house in order,

we think it can start ringing the cash register. Yeah. Elliott Investment, they are no joke. And they are specifically no joke within the social media segment. They've done great things at eBay. They were on their board. They've been on the board at Twitter. Maybe that's still a little bit of a work in progress. But they're not coming in. When you think of activist investors, you think of someone who's coming in and it's the Gordon Gekko, we're going to shake things up. They don't really have that opportunity to do so at Pinterest because the founder, Ben Silverman, has the lion's share of the votes. He's got 37% of the total votes. They can't come in and push him around. Ben Silverman decided to step away in June. Bill Reddy is the new CEO, ex-Google guy.

I would suspect that Elliot had a hand in having him come. It's going to be really interesting to see what they have to say as things progress at Pinterest. Pinterest is really the largest data set that's out there for consumers that is not aligned with one of the big companies, with Facebook, with Google, with Apple. So, it's a great resource. It's going to be really interesting to see how this plays out. Because to this point, nothing that Bill Reddy, who, as you said, has been CEO for about an hour and a half, nothing he has said, and nothing that we've heard from Elliott Management, points to pie-in-the-sky aspirations, both in terms of future guidance or in terms of levers that they can pull.

They're talking about some pretty basic blocking and tackling ways to monetize the platform in a way that seems like it would be additive to the experience for people who use Pinterest, and wouldn't drive them away. My hunch is that they are keenly observant of the language around Instagram, and how people who have been on Instagram for a long time are talking about how the platform has changed, and changed in a way that they don't really like. There is an opportunity here. You want to say, good luck. There's a way for you to do this without blowing it. Yeah. One of the things that they've pointed to was their international markets, where on a per-user basis, they're only making

a dime to about $0.15 per user. It should not be hard if you are at that level. Just to level set, Twitter makes a couple of dollars per user. Twitter, again, not even close to the best participant in this market. Pinterest has not done a great job in monetizing a huge amount of its members who show up and create their own material, they create their own content. So, they have a partnership with Shopify that they signed in 2020 that I think that they could lean on more. So, you are not talking about an experience that should be that markedly different for its user base, which is always a risk. If you come in and you turn it, You go from being, this is something that is as helpful as possible to, it is as profitable

as possible. Well, that's great, but you're going to be profiting off of a smaller user base by virtue of pushing people out. So, Pinterest, it's good news and bad news. They don't have to do much to be a much, much more profitable company. Let me ask you something about activist investors. You said, the image of Gordon Gekko coming in, we're going to shake things up. I mean, that's true in some cases. Is Elliott Management an activist investor that when you see they're involved in this company, the reaction you have is positive? And if not, are there ones out there that you think, oh, OK, this activist is getting involved? Alright, I'm going to pay a little bit more attention to this situation

because these are serious people, these are not rabble-rousers? It's a really good question. I would put Elliott at the top of the list, along with Gotham Partners, with Bill Ackman and Janna Partners, which are activists who aren't coming in looking for that quick hit. That's always the thought. Again, I brought up Gordon Gekko earlier. Obviously, in Wall Street, that's what he was trying to do, to break up the company and profit any way that he possibly could. These folks are long-term investors. Now, they do come in with smiles, but they are capable of going more hostile if they need to, but that's not their MO. Oh, and as you said, in the case

of Pinterest, that's not going to work. Well, it could work. Yes. It's not going to work in the way that it would work with other companies where the founder is not there with the lion's share. Right. They can't vote anybody out by themselves. A proxy battle is not going to work out for them very well, because at least 37% of the votes are already against them. But there are other levers that they could pull. I mean, you saw it with Uber, where basically, they embarrassed Travis Kalanick out of the building. So, there are things that they could do, but I would not expect that to be the case with Elliott and Pinterest. Bill Mann, great talking to you, as always.

Thanks for being here. Thanks, Chris. Are we in a recession right now? Are we headed toward one? Apparently, it's a little more debatable than we all thought. Alison Southwick and Robert Brokamp discussed the indicators commonly associated with recessions and which ones they're watching. Here's something you're probably hearing in the news a lot lately. Key indicator falls, fueling recession fears. Yes, the GDP declined for the second quarter in a row, and that is a big one. But what about the VIX, the jolts, and someone named SOM who is making rules? As we've briefly explained before, recessions are officially declared by the National Bureau

of Economic Research, which defines them as, quote, a significant decline in economic activity that is spread across the economy and that lasts more than a few months. While NBER is the final word, they tend to be more backwards looking, like someone assessing a car accident. You know your car has been damaged, but you don't know the extent until you get an expert opinion. So today, we thought we'd talk about some of those numbers to watch that are perhaps a little bit more forward-looking, what they mean, and if they really are harbingers of dark times ahead. Yeah. We're going to take a look at four things that may or may not give you a hint about what the economy and the stock market

is going to do. What's first up, Alison? The VIX. What is it? Well, bro, the VIX is created by the Chicago Board Options Exchange, or CBOE, and it's the volatility index, or the VIX, as it's efficiently and affectionately called. It's also known as the fear gauge, super not foreboding at all. It's a forward-looking benchmark for volatility over the coming 30 days. How? Well, they look at the prices of S&P 500 index options with near-term expiration dates. Apparently, it's quite a complicated formula, and you're welcome to Google it yourself. While not always true, typically, the VIX rises when stocks fall and declines when stocks rise. The higher the VIX, the more feariness and uncertainty ahead. The highest the VIX has

closed at has been in the low 80s. And that was back in March of 2020. And the lowest it has closed is around nine. And that was in November of 2017. Currently, the VIX is hanging out in the low 20s. Yeah. So it is right now at 21, which is the historical average. That's down from above 30% in mid-June. And it came down because, as you pointed out, it goes in the opposite direction of stocks. And stocks went up. In fact, in July, the S&P 500 returned 9%, and the Nasdaq returned 12%. So, last July actually was the best month for stocks since 2020. So, stocks went up, the VIX came down. So, you might ask, does any of this matter? And I would say, on most days, actually, not really. I think the VIX is most interesting in the extreme.

You probably have all heard that old Warren Buffett adage, be fearful when others are greedy, and greedy when others are fearful. At readings in the low teens or even lower for the VIX, it could mean that investors have gotten greedy and maybe complacent. It generally happens after a few good years. You pointed out the lowest reading was in 2017. Another time when it got almost that low was 2007. In both of those years, the following year, the market drops. We're not market timers at The Fool, so we're not saying that if the VIX is low, you should sell. But if the VIX gets real low, especially after a string of several good years, you might want to think about rebalancing your portfolio.

What about the other direction, when the VIX has shot up? After all, there's another adage, when the VIX is high, it's time to buy. According to Hartford Funds, there have been eight times when the VIX has been above 40 since 1990. That was the year the VIX was launched. These usually have been times when the market has either hit a blip or was in a full-blown bear market. Was that a good time to buy? The S&P 500 posted a positive return a year later in six of those eight times. Basically, a 75% success rate. That's actually about right in line with the historical average of stocks making money in three out of every four years since the 1920s. But I calculated the average one-year returns of the S&P 500

after the VIX hit 40, and I got 17%. That's well above the long-term average of 10%, though, again, that did include a couple of down years. Three years after the VIX hit 40, the market was in positive territory every time, though the jury's still out on the last time, which was during the pandemic panic of 2020. But we'll get the verdict on that in early 2023. So, there might be something to buying when the VIX is high. But during times when the VIX is just kind of moseying around, not particularly high, not particularly low, kind of like right now, I don't usually pay too much attention to it. All right. Let's move on to our next number to watch. The New York Times calls it Wall Street's most talked about recession indicator,

and it's sounding its loudest alarm in two decades. It's the yield curve. Yes, the yield curve compares the interest rates of various U.S. government bonds, notably three-month bills and two-year and 10-year treasury notes. Typically, investors expect to earn higher interest when their money is tied up longer. So, the 10-year pays more than the two-year, and the two-year pays more than the bills that mature in three months. So, if you plot them on a chart with maturity time on the X-axis and the rate of return on the Y-axis, it makes a curve up and to the right, just how we like our charts here at The Motley Fool. But every now and then, things get inverted. And the interest rates for shorter-term U.S. bonds are higher than the rates for longer-term

bonds. And the curve bends the other way. And that way, it's down. And we like graphs that go up. When the yield curve is inverted, it reflects the feelings of investors that the economy is going to tank, and it's got some predictive power. So, you may be wondering, well, what is the yield curve up these days? Well, apparently, the signal it is sending hasn't been this dire since late 2000, when the bubble in tech stocks had begun to burst and a recession took hold. This is what I'm seeing in the headlines, bro. Is it really that dire? I would say this is actually one that I do pay attention to. According to a reserve study published in 2018, the yield curve has inverted before every recession since 1955. That said, the timing is rather variable. The

recessions have come within six months to as much as three years after the inversion. So it doesn't mean you have to panic immediately. And according to Anu Gaggar of the Commonwealth Financial Network, the spread between the two-year and 10-year notes has inverted 28 times since 1900. In 22 of these instances, a recession followed. So there have been six false alarms over the 120 past years. But still, it's a pretty remarkable record. So where are we now? So the two-year, 10-year yield is inverted. The two-year is yielding 2.9%. The 10-year is 2.6%. That 10-year has come down pretty significantly since above 3.5% in June. That's been a big drop. But the three-month and 10-year is not inverted. Many people think that's the one you should pay

most attention to, including Fed Chair Jerome Powell. But the bottom line is, regardless of whether or not we enter a technical recession, the yield curve is telling us to expect that economy is going to be sluggish for a while. All right. Next number to watch. Housing starts track how much residential housing was, well, started. It's a weird little phrase, but somehow it works. The Census Bureau releases the figures on the 12th business day of the month. They estimate housing starts from building permits issued by a sample of local permitting offices and then track those projects through completion and sale. Buying a new house is a big ticket item. Then, of course, you have to fill it with stuff. If there are a lot of houses being built in response

to demand, then that's a leading indicator of the health of the economy and future spending. It reflects the level of America's optimism and ability to even afford a house and all the things that go in it. How are we feeling, America? Are we ready to go buy a house? Well, new U.S. home building activity fell to a nine-month low in June. Not great. But with all the supply chain issues and rising interest rates, you're probably not too surprised to hear that. Yeah. I think it's important to think about all the parts of labor that go into building a house. There's all the materials, and then there are all the workers, the plumbers, electricians, to turn it into a house, and not to mention all the sales team that gets together and sells the

place. That's a lot of economic activity under one new roof, and a lot less activity when fewer walls and roofs get constructed. That's what's happening now to new homes and also to existing homes, but it's the decline in housing starts that can really weigh on the economy. Lance Lambert wrote a good article for fortune.com in which he argues that this is what the Fed wants because it'll bring down inflation. And here's one of the early paragraphs. Quote, historically speaking, the Federal Reserve's inflation-fighting playbook always starts with housing. It goes like this. The central bank begins supplying upward pressure on mortgage rates. Not long afterwards, home sales sink and existing home inventory spikes. Then home builders begin to cut back.

that causes demand for both commodities like lumber and steel and durable goods like windows refrigerators to fall. Those economic contractions then quickly spread throughout the rest of the economy and, in theory, help to rein in runaway inflation." Frankly, so far, it's working. Sales are down, inventory is up, and an increasing number of people are canceling their housing contracts. Housing starts are something to keep an eye on, and right now, they're not looking too good. We talked about housing starts and then, of course, before that, the yield curve. Both of those seem to suggest that a recession is a common around the mountain. But there's a reason why Harry Truman once said, give me a one-handed economist. All of my

economists say on the one hand, but then on the other. And these days, the other hand is unemployment. Many experts argue that it's hard to say we're in or near a recession when unemployment is at 3.6%, the second lowest rate over the last 50 years. There are almost two openings for each person looking for a job, which is historically very high. So how will we know when things begin to change? Well, you could look at the Job Openings and Labor Turnover Survey, aka the JOLTS, put out every month by the Bureau of Labor Statistics. And job openings are indeed starting to fall as of the May numbers. But if you're looking for how we'll know if the job market is indicating we're in a recession, well, have you considered the SOM rule developed by the

former Federal Reserve and White House economist, Claudia Somm. According to this indicator, when the three-month moving average of the national unemployment rate rises by 0.5% or more relative to its low during the previous 12 months, we're likely in a recession. Yeah, the Somm rule is a relatively recent development. It was just announced to the world in 2019. And by the way, Somm is spelled S-A-H-M, in case you want to look it up. And according to the original research paper, since 1970, there were no false alarms. Thus, it seems like a pretty good recession indicator from the job market. So, what is it saying today?

Well, the current unemployment rate of 3.6% is the lowest we've seen over the past year. So, the SOM rule would be triggered if the three-month average rose to 4.1%. Given how the job market looks, it seems like it would take several months to get to that point. But we'll keep an eye on it. Now, Bloomberg, they also do a monthly survey of economists, and they found that the probability of a downturn over the next 12 months stands at 47.5%. That's up from 30% odds in June. Bro, after we've finished talking about all these numbers and all the feels, the question is, does the fear of going into a recession, should that change how you invest and save today?

It certainly makes sense to keep an eye on these things. If you are in or near retirement, once things start looking a little dicier, it might make sense to play it somewhat safer, maybe rebalance your portfolio, maybe have a little bit more cash on the side. Of course, the market is already down. Some of these indicators, like the flattening of the yield curve, were giving a warning at the end of last year. If you paid attention then, that would have been a good time. If you're still working, the number one risk of recession is job loss or maybe a pay cut. What you should be doing is really taking a look at your job and making sure you're demonstrating as much value as possible to your employers and your customers

to ensure that you'll still be able to earn a paycheck regardless of what happens to the economy. As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening! We'll see you tomorrow.