When your Greek friend gets you a gift for no reason
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When your Greek friend gets you a gift for no reason
What the Market? - July 25, 2022
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What the Market?
Mr. Market like the rest of us, occasionally needs to find ways to suffer well. Sometimes, it means laughing through the pain, maybe imbibing in a few too many and dancing on a table, or some retail therapy, whatever floats your boat really. This week, Mr. Market did a little dance, and raised the roof a bit. All major indices rallied and the 10-year bond yield dropped a bit. Don’t be fooled, we’re still in a bear market. This week will be one of the busiest of the year for Mr. Market, and like others prior, all eyes will be on the Federal Reserve. The Fed is expected to announce another rate hike of 75bps. On top of that, this week is THE earnings week. Over 50 of the S&Ps largest companies will report earnings; expect volatility. Plus, we get to find out if we are in a recession!
What’s driving the market?
To hike or not to hike? It is not a question anymore: This Wednesday, the Fed is expected to announce a 75bps interest rate hike, bringing rates up to a range of 2.25 - 2.50%. Both consumers and businesses are feeling the pain. We’re already seeing changes in consumer habits, particularly at the grocery store and at the pump, concluding that consumer spending is not as strong as initially reported.
Your friend who always says “technically” before saying anything: So technically, we find out whether or not we’re in a recession this week. The Q2 GDP growth estimate report will be released on Thursday. The US economy contracted by 1.6% in Q1, so a second contraction would mean we’re technically in a recession, per the definition. Economists expect an identical -1.6% contraction for Q2, driven by the inflationary pressures and the subsequent (delayed) monetary policy response.
Silver linings: A significant part of a (mild) recession has already been priced in by Mr. Market; economic slowdowns are healthy (after periods of significant growth) and reduce inflationary pressures, allowing overheated markets (looking at you, housing and energy) to balance back with the rest of the economy.
Earnings season: With only about a 5th of the S&P 500 companies reporting so far, growth has beat expectations by roughly 4.2%. Earnings are showing tightened margins as expected in a high inflation environment as cost of goods increases. Overall revenue growth has been steady, so maybe it’s not all that bad? We’ll be focusing on guidance and any juicy commentary about what lies ahead and the current macro environment.
When your friends don’t want to play with you because you’re too strong: Because the Fed doesn’t have enough to worry about, talks of a possible “doom loop” involving the U.S. dollar have begun circulating. Let’s break the Doom Loop down:
The US dollar is currently the world’s reserve currency, this means other countries borrow, save and spend in USD.
If the dollar strengthens, countries and international companies’ debt becomes harder to pay off.
Creditors worry that borrowers won’t be able to pay, and restrict lending.
Unable to borrow, global economies, manufacturing, and trade may start slowing down.
The world worries about the potential global slow-down and soft currencies deteriorate, so countries look to the reserve currency (USD) for stability.
Demand for USD goes up, and thus gets even stronger.
What makes this a little scarier than usual? Well, typically, the Fed would just lower interest rates to weaken the dollar or print some bills. However, the Fed can’t do that while inflation rages on domestically. Hmm maybe if you had raised rates just a tad during a 12 year bull market (excl. pandemic bull run) instead of waiting for rampant inflation to cue action, but we’re not economists… So yes, the Fed will be a key player in propagating the Loop attempting to curb inflation. This should be a fun side-story to watch.
What’s an investor to do?
Portfolio Management
Oh a market rally? So it’s time to buy right? Don’t want to miss out? If you’ve had any of these thoughts this week, then follow these directions carefully: call your brokerage and tell them to lock you out of your account for the week. Tell them, you have a bad case of the FOMO, and need some time off.
Yes, stocks rose last week, yes, the S&P is doing better than last month. Rallies are normal and expected during bear markets, but it’s still a bear market. This is not a time for FOMO buying, do your due diligence and invest carefully. We may have reached market bottom, we may have not. As a frame of reference, the average bear market for the S&P 500 has historically taken about a year to bottom.
The key word you’ll start seeing floating around the news and social media is capitulation (fancy word for bottom), and if we’ve reached it. For now, the answer seems to be NO. So, be patient.
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 re-entering into long-term positions that may be flirting with historical lows due to the macro context. Proceed with caution and know 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 too undervalued and weathering the storm?
What are we up to?:
Diversifying currency exposure: A highly speculative and LONG-term idea we discussed was whether we may see a change in the global reserve currency. Over the last decade, countries have been moving to reduce their reliance on the USD as THE reserve currency, and have started saving and borrowing in other hard currencies. Furthermore, we’ve seen the rise of China, and the increasing adoption of cryptocurrencies. With a strong dollar potentially weakening global trade, could the trend exacerbate? The last reserve currency switch was from the British Sterling in the 1920s, and reserve currencies historically reign for about a century. Could we be in the middle of a transition? What would be the next one? Bitcoin, the Yuan? We repeat, this is a highly speculative and long-term idea. For those interested, here’s a lil’ history on reserve currencies.
Value small caps in stategic sectors: Small caps have been underperforming large caps and defensives - a pessimistic signal. This does offer an opportunity to snag up high quality small caps at a low valuation and wait for the bull market where small caps typically outperform.
Keep an eye on the economy
Tuesday-Wednesday: the FOMC interest rate decision
Thursday: GDP growth estimates report
All Week (see below): Slew of earnings reports
See here for the full economic calendar
The Curious Investor
Easing of Grain prices as Russia and Ukraine agree on resuming grain exports
Russia resume Nord Stream Natural-Gas Supply to Europe - could it reduce pressure on energy prices?
The strong dollar takes a toll on IBMs earnings, Netflix may be next
The US government has no idea what to do with semiconductors
Upcoming Earnings:
There are a TON of companies reporting this week, this list is only a clip. For a full list see here.
Travel/Auto: Hertz, Southwest Airlines, General Motors
Tech: Alphabet, Microsoft, Intel, Spotify, Shopify, Amazon, Apple, Meta
Financial Services: Mastercard, Fiserv, Visa
Consumer Defensive: Procter and Gamble, General Electric
Commodities: Chevron, Exxon, U.S. Steel
Join our Slack Channel for free access to additional earnings coverage:
What we’re vibing:
How Proust Can Change Your Life by Alain de Botton: A hilarious self-help book that offers advice on cultivating friendships, saving relationships, learning, and enjoying life. In Botton’s perceptive literary biography of Marcel Proust, the author of the 250,000 word novel (about 4,000+ pages), In Search of Lost Time, you’ll learn why you shouldn’t use cliches, why infidelity is the only way to save a relationship, why even the finest of books should be tossed aside, and more. A fun short read that may just change your perception of lessons you thought you already learned.
Chernobyl - HBO Series: Okay, well aware that we are WAY behind the times on this one (it came out in 2019) but…holy roentgen! We’ve read a lot about Chernobyl, but this award winning series truly makes you feel how insane the nuclear disaster was, how mismanaged it was, and how close the world came to ending. Even crazier, that mad man Putin sent troops there and staged a battle next to this disaster site just months ago! (Deep breath in, deep breath out, repeat…)
Resources
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