Solid earnings reports from Pepsi and Disney helped to boost futures prior to the market opening yesterday morning. Unlike the past few months though, stocks turned south during live trading hours, resulting in modest losses for major averages as 9 of the 11 S&P sectors finished in the red. This also followed a rough session on Wednesday where a host of Fed speakers dampened sentiment while offering hawkish forecasts. Interest rates are perking up globally, with German 2-year yields spiking like a rocket ship. This should come as no surprise with recent payroll data showing a massive gain for the employed and Fed futures pricing in more rate increases. The CPI report next week could be critical for the next big move.
Interest rates continue to confound stock bulls with an inversion of the yield curve now at its widest point since 1981. J.P. Morgan’s Chief Economist noted, “Very few of our colleagues in J.P. Morgan strategy see a recession priced into their markets. The one exception is interest rate markets. An inverted yield curve is a strong signal of an impending contraction, and the current spread between 10-year and 3-month Treasuries is inverted by around 100bps, a deep inversion consistent with very elevated recession risk.” One of these markets is wildly mispricing the future path on rates, GDP and potential recession.
Major Averages and New Leadership:
The rotation out of last year’s winners (Defensive, Staples, Utilities) and into old losers (Communications, Technology, Discretionary) continues unabated. Small cap and mid cap stock leadership also shows that investors are more willing to take on risk in 2023. All of which comes despite one of the most predicted recessions in recent memory. Further, investors are starting to accept that the Fed will not end the rate cycle prematurely, nor will they be quick to start cutting interest rates soon after. Rate cuts are all but priced out of 2023 already (they are down to just 20bps).
Two-thirds of the S&P components are back above their 50 – 200 day moving averages, but are only showing minimal overbought readings. Trend followers prefer to see new uptrends. FOMO (Fear Of Missing Out) is back, as is short-covering. Bears are going back into hibernation with over $300 billion in short positions covered this year.
I have shown the downtrend lines for the major averages over the past several months and once those lines were crossed, stocks have spiked. As you can see below, many would say this bear market is over and a new uptrend is here.
Source: Piper Jaffray
Source: Piper Jaffray
Just as we did not become more bearish after a 25% correction in stocks last year, it is difficult to get overly bullish following such a move (as Jim Meyer noted on Wednesday). The S&P is up 7% and the growthy Nasdaq has already bounced 14% following the flip of the calendar. They are both up 18% since lows in October. This could certainly be the start of a new bull market, but it is unlikely to be this easy going forward. There are many issues to still deal with, most notably the inverted yield curve, multi-decade high interest rates, tightening of loans, still elevated goods prices, dwindling savings accounts, above normal stock valuations and negative money supply. Combined, these are all pieces that precede a recession and an earnings decline. Taking out housing and banks, P/E multiples are back near 20X for much of the market, and with likely downgrades to the “E” side of a simple equation, it behooves one to make sure to stick with quality, high free cash flow and clean balance sheet leaders. Momentum works until it doesn’t. Better to have a plan and lock in some sizable gains if you have them in companies that may not be ready for a slow growth decade. Lyft, Royal Caribbean, Spotify, Tesla#, Lucid, Peloton, Coinbase and Roku are up 50% – 100% already this year!
Artificial Intelligence :
There is always a bull market somewhere. No industry changes as quickly as Technology in that regard. The century started out with a dotcom bubble, followed by an explosion in network providers, broadband demands, the advent of the smartphone, streaming, social media, cloud hosting, etc. It is becoming quite clear that the next phase is working with artificial intelligence which carries a multitude of useful and useless products coming our way.
Microsoft’s recent $10 billion investment into OpenAI, the startup behind a popular intelligence tool called ChatGPT, has started firing up FOMO juices yet again with anything tied to AI being heavily scrutinized and money piling in on all sides. In fact, ChatGPT, which launched in November 2022, already has over 100 million users, making it the fastest growing consumer application ever. On a daily basis, it receives 10 million queries, costs ~$100,00 to run, and is expected to earn over $1B by next year. Microsoft is integrating this service into their flailing Bing Search Engine among other areas.
Microsoft’s CEO, Satya Nadella, was quite clear in his presentation this week, noting that AI will be applied everywhere and can help make all of their software services more efficient, intuitive, cost-effective and innovative. First and foremost, though, is the very profitable search business where Google has ~93% market share and Bing has only ~2%. It is estimated that every 1% in market share that Bing can gain will generate $2 billion in additional revenues. They also carry very high margins, but Mr. Nadella laid down the gauntlet with respect to Google, noting, “From now on, the (gross margin) of search is going to drop forever…there is such margin in search, which for us is incremental, for Google it’s not, they have to defend it all.” Those words speak volumes.
Google followed up with their own AI presentation, showing their product, named Bard, coming up with a wrong answer during the demo. Not a great start. Google’s stock was taken to the woodshed over the past few days, dropping 13% and taking off nearly $150 billion in value. That is equivalent to FedEx#, Ford and Simon Property Group#, combined, in just two days of trading. Crazy, right? Well, Microsoft has added over $300 billion in market value since announcing their additional investment into OpenAI a few weeks ago. Is this the next bubble? Probably so, and we are just getting started and have not even touched upon other upcoming trends like metaverse, autonomous driving, automated factories, robots, genome sequencing, etc. The future is bright and filled with more innovation. Interesting times ahead.
Back to Google; they are not sitting idly by. Their investments into AI development started several years ago and they have been pumping billions into Bard. While perhaps not ready for primetime viewing and consumer usage today, Google has a premier management staff and is going back to its original Dream Team of Larry Page and Sergey Brin for assistance in dealing with implementation of AI throughout their businesses. This will be an interesting battle, one where consumers are likely to benefit by Big Tech’s massive spending efforts, and hopefully more useful products down the road.
Elizabeth Banks is 49 years young today. Laura Dern turns 56. Robert Wagner is now 93. After the Eagles win the Super Bowl on Sunday, all eyes will turn towards Spring Training camps for baseball. I do not think that Lenny Dykstra will get an invite for a multitude of reasons, least of which is him turning 60 today.
Let’s go EAGLES!!!!
James Vogt, 610-260-2214