A little Column A, a little Column B
A little Column A, a little Column B
What the Market? - July 18, 2022
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What the Market?
Mr. Market hasn’t been the happiest fella on the block this year. Although he was able to get a little reprieve from the retail sales report coming in above expectations and a strong jobs report, inflation and central bank policy moves still weighed heavily on his mind. If you were to ask Mr. Market how he feels about things, he may just describe it in a single word, ASUFUTIMAEHAEHFUTBW. Lackluster earnings to kick off the season, a deepening yield curve inversion, oil prices dropped on lingering concerns of a recession and slowdown in demand for fuel. Meanwhile, demand for safe haven assets (e.g., bonds) has stayed strong as investors look to protect their downside.
What’s driving the market?
If only your duck floaties were all that was inflating this summer: Last week’s consumer price index (inflation) data was quite disheartening. Prices rose faster than expected and hit 9.1% annual in June (a 41 year high). Which means Cotton’s bold strategy isn’t paying off and the Fed needs to figure out its next move to stabilize prices (cue further and earlier rate hikes?). The interesting thing to note was that the S&P 500 actually rose while the 10-year Treasury yield fell after CPI data was released. Could this mean investors are starting to look past inflation and slower economic growth? Hard to tell, keep an eye on inflation and macro environment commentary in the upcoming earnings releases.
Highlights from the CPI report:
Energy prices up 42% YoY, +7.5% MoM - accounting for nearly half of the overall increase to inflation
Food prices had their highest increase since 1981
Dropping commodity prices: Oil dropped to lowest level since the invasion of Ukraine, gas prices have dropped a tad, copper continues to decline (bellwether for the economy)
Core Inflation (excludes food and energy prices): rose 5.9% YoY, down slightly from 6% YoY last month
Lower commodity prices may help moderate inflation (cost of goods decreases) against additional inflation pressures (e.g., wage growth, tight labor market, supply chain).
GDP and the Jobbies: Last week’s Job’s report came in stronger than expected. The economy added 372K non-farm jobs in June. Unemployment remained at a healthy 3.6% for the 4th consecutive month while wage growth rose by .3%. However, the labor force fell by 353K (a drag on the labor supply which has the potential to keep the unemployment rate low even if job growth slows). The Labor Department also announced that there are 11.25mm job openings at the end of May - that’s 1.9 job openings per unemployed worker! While we are experiencing gains in employment, GDP growth hasn’t been so strong which begs the question are we increasing production and efficiency with these new jobs?
Whitney could bend a note, but could she bend a yield curve?: The recent yield curve inversion is an eye brow raising worthy signal. This means yields on shorter-term debt is higher than on longer-term debt, specifically the 10 year and 2 year treasury yields. This means investors are not feeling all too great about the short-term (there is more risk now rather than in the more uncertain future), and is often seen as an early recession signal. Yield curve inversions have often come within 1-2 years before a recession.
A quick note on the USD/EUR relationship: Since Q3 2021 the dollar is up a whopping 20%. Albeit great news for those trying to take advantage of a quick escapade to European lands, it may be a threat to multinationals repatriating their overseas earnings into dollars. The Federal Reserve and the European Central Bank have followed different trajectories in recent months regarding how to fight inflation and a potential recession. US Central Bankers have been raising interest rates aggressively to fend off surging inflation, while its European counterpart has yet to raise rates. The euro has fallen below parity (1/1) for the first time since 2002. This week the ECB is expected to (finally) hike its benchmark interest rate at least by 25bps. This would be the first rate hike in over a decade for Europe. TLDR, while the US has had a not-so-great response to inflation, Europe has yet to communicate and start executing a plan for it.
What’s an investor to do?
Portfolio Management
It’s been a rough year. The bear market news has mostly focused on the fall of speculative and tech stocks. As recession fears pile up, we are still playing defense with our eyes looking for the opportunity beyond the pullback. Yes, market risks have increased, but lower equity valuations and higher bond yields have improved future returns. This is the time to start researching.
Investment strategy: Based on your risk appetite, consider a smoothie of the following ideas:
Lean into Defensive / Flight to quality: more value stocks, consumer defensive, commodities, corporate bonds with short durations and even inflation-linked bonds.
Consider re-entering the market cautiously: Consider reentering into long-term positions that may be flirting with historical lows due to the macro context. Proceed with caution and trust what you are buying.
Research: This is the time to start looking beyond the slowdown and formulating your strategy of what sectors and companies are going to thrive once we’re on the other side. What companies are way to undervalued and weathering the storm?
What are we doing?: Small caps are looking quite cheap, so we are trying to strike a couple of bargains. Small caps are currently running around 20% below their historical averages and are trading at 2008 levels vs mid and large caps. Fun (?) fact, since the 1930s small caps have outpaced inflation and tend to recover more quickly than blue chip stocks in post-recession environments.
Keep an eye on the economy
Earnings Season continues: Focus on earnings and their commentary on the macro economic environment. A list of upcoming earnings this week is below.
See here for the full economic calendar
The Curious Investor
How Inflation Distorts Earnings: A good read on how to interpret earnings in a time of inflation. TLDR: pay attention to sales volume in terms of units not just in revenue. Inflation impacts company’s P&Ls in different ways. When higher costs are passed onto consumers in the form of higher prices, it can make sales $$ increase on lower volume. Lower sales volume means lower demand and that there is price sensitivity. Pro-tip: Check out how margins are affected by inflationary pressures!
Upcoming Earnings:
Airlines: United Airlines
Financial Services: Bank of America, Charles Schwab, Goldman Sachs, Nasdaq, Ally Financial, Citizens Financial, American Express
Other: IBM, Kaleido Biosciences, Johnson & Johnson, Lockheed Martin, Nokia, Philip Morris, Netflix, Twitter, Verizon Communications
Join our Slack Channel for free access to additional earnings coverage:
What we’re vibing:
Road Runner - A film about Anthony Bourdain: There are so many things we could say about Anthony Bourdain it’s hard to put it in a blurb. He was a romantic who saw the world in such a way that he inspired an entire generation to travel and explore the world. This film, gives you a peak into the man throughout his life from those that worked with him throughout his whole career. Expect to be filled with joy, curiosity, and for the sensitive souls like us…to cry.
Subtract - Derek Sivers: A short little read on a philosophy that has helped us start finding some peace, a little less stress, and a lot more joy in life. Often times we find ourselves missing things in life, and so we add more to it, but what if we subtract? Focus more on less, what will happen?
Resources
Learn to invest with our recommended content (books, books, books!)
Disclaimer
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