- Japan & Europe already have negative interest rates and big stimulus programs. The US could be next in line.
- If this happens, it will be a sign of an impending recession. McDonald's outperforms in recessions as demonstrated in 2008.
- The loyalty program has the potential to meaningfully increase sales comps. Ordering meals through mobile will come sooner than many think.
Many investors look to valuations of the underlying before deciding on an investment but history has shown us that many underlying with good fundamentals and low valuations can stay undervalued for a significant period of time. Therefore, we must go deeper with our analysis to ensure we attain the highest probability of success on our respective underlying.
The great recession of 2008 taught many investors and central banks a lesson which I believe will not happen again for a significant period of time. Many bears are waiting for a pullback in US equity markets - a pullback that may never come. With the dollar coming off its highs, precious metals and especially oil have recently rallied strongly and if the dollar were to weaken more from here, I believe equities would also participate in the rally.
Inflation usually causes prices to go up in all asset classes and although commodities may be more undervalued at the moment, ongoing dollar weakness should boost earnings of many US multi-nationals. In fact, the more dovish the Fed gets, the more inherent weakness it is seeing in the US economy. Therefore, with Japan and Europe adopting huge monetary measures to stimulate growth, its baffling why many analysts believe that same won't happen in the US. Investors need to understand that a rising stock market is not necessarily a sign of a stronger economy as markets are heavily manipulated at present. Therefore, markets could easily go higher but economic conditions could worsen (recession). If this hypothesis plays out, McDonald's (NYSE:MCD) earnings multiple could go much higher and not lower like many bears think. Here is why McDonald's stock might actually be a strong buy now which would destroy many bears currently shorting or about to short this stock.
Firstly, if you believe McDonald's is overvalued at the current price of $123 a share and an earnings multiple of 25.9, well in 2007 the earnings multiple reached 30.5 just before the recession hit. However, it was its performance in the recession that really made this company stand out as a recession-proof stock. McDonald's current 10-year earnings multiple average is 19.59 and the stock did eventually revert back to its averages but not in the way the masses believe it would have - a falling share price. In fact, earnings per share went from $1.98 in 2007 to $4.11 in 2009 which meant the share price didn't fall at all despite the initial high price to earnings ratio. Now what we had in 2008 was a deflationary recession but the next recession I fear will be inflationary which should really boost McDonald's stock price. Why?
Well, McDonald's was able to outperform despite the dollar index going from 72.5 to 87.5 in 2008 which leads me to believe that an inflationary recession would be even more bullish for the restaurant chain considering up to 60% of its top line comes from international markets. Remember if markets continue to go up, it will be the companies that consistently beat earnings that will experience share price growth irrespective of their valuations
Secondly, I have always stated that the S&P 500 (INDEX:SPAL) would need to fall more to confirm a strong bear market bottom, as the trend line from the 2009 lows and 2011 lows still hasn't been breached. In fact, the index only retraced 13% between its 2015 highs and the February lows which still wasn't enough (20% usually is the norm) to say a firm bottom was hit. However if we look at the NYSE Composite (INDEX:NYA.X) chart, we can see that over the same period, this index retraced 20% illustrating that a bear market bottom could have definitely been printed. Why do we concentrate on the NYSE chart? Well, this index has no futures market so market interventions or manipulations are much harder to accomplish. Also, the index gives us an idea of the real selling pressure that occurred and as we can see from the chart below, the 20% retracement caused the trend line (marked in red) to be breached. What's the takeaway? Well, it looks to me that stocks may be entering a new fresh bull market and once the market breaks out to new highs, you could see a violent rally to the upside as bears start to scramble to cover their shorts.
Finally, with the market always being forward looking, McDonald's newly implemented loyalty program could spark new momentum in the stock if the initiative takes off. Starbucks (NASDAQ:SBUX) has already had a huge success with this endeavor and McDonald's wants to follow suit which could be a game changer. Why? Well, up to now, the restaurant chain has only listed promotional offers on its app but if customers can save more based on consumption, more repeat business among customers will become a certainty. Furthermore, with customers potentially being able to order their food on their smartphone as well as being notified of promotions, it stands to reason that more sales will be done online which should boost sales comps meaningfully. All the street needs to see here is a trend in one market and if results come back positive, the market could substantially revalue this stock like it did last October when the "All Day Breakfast" stopped negative US sales comps in its tracks.
To sum up, McDonald's stock may currently have a high valuation compared to its historic averages but if equity markets in the US are at the beginning of a new bull market (which I expect), this stock automatically turns into a buy. Why? Well, it is recession proof, has definite momentum, has 65% of its operating profits coming from international markets and its new loyalty program has the ingredients to spark meaningful momentum if Starbucks is anything to go by. If the S&P500 breaks out to new highs and we have a weaker dollar to boot, McDonald's stock would be a strong buy in my opinion