Fear and greed have a tendency to creep into markets time and time again. During Covid lockdowns, stocks collapsed 35% in a matter of weeks…fear was rampant. Then the printing presses started and major averages more than doubled, with the worst run companies, cryptocurrencies and meme stocks stoking the greedy side of the masses. A tighter Fed and one of their quickest tightening phases in history helped bring stocks back to, or below, fair value last year. While 2023 started with a solid rebound in oversold areas of the market, some froth has come back to the fore yet again.
On Wednesday alone, the list of little-to-no earnings companies which were crushed last year showed massive short covering and tremendous gains on less than feared earnings reports. Here are some of the amazing one-day gainers for companies that do not even turn a profit: Upstart +28%, Roblox +26%, Quantum Scape +32%, Coinbase +17%, Affirm Holdings +12%, Roku +12%, Carvana +18%, AMC Entertainment +15%, WeWork +11%, DoorDash +10%, GameStop +8% and Rivian Automotive +7% to name a few. This list could go on and on, but you get the point. Stocks with low ROE’s, negative earners, high leverage, low market cap, and high short interest have been outperforming within both Large Cap and Small Cap in recent months. This is typical of a new bull market, but unsustainable. Gains like these were unimageable a year ago and unwarranted today.
The Fed will not like euphoria coming back to the stock market as it makes the inflation battle much more difficult when investors are seeing gains like these in their portfolios in questionable companies. In fact, yesterday afternoon a couple of Fed officials went so far as to say that 50bps is back on the table for March’s meeting. We doubt that will actually happen, but the intent to quell some overzealous market conditions is quite clear. Even with all the rate increases, 2023 first quarter GDP is looking stronger than in 2022. Stocks cratered following those Fed speeches and futures are weak today as well. Higher for longer, as the bond market has been pricing in, is starting to get repriced into stocks.
Fourth quarter earnings reports are winding down, with a slew of retailers set to report this week. Following a surprisingly strong January retail sales report, a lot of good news is being priced in. The consumer is far from dead. Whether it was due to good weather, use of Christmas gift cards or the cost-of-living increase for retirees being the reason, consumers are out and about. The Holiday season was not great, but 2023 is off to a solid start. This report alone is causing many economists to adjust Q1 GDP from 0.5% to 2.0%. While we do not want to dismiss a strong report, one must remember the weak end of 2022, which makes the previous three months of retail sales flat, or basically down in “real terms.” It is also highly likely that this boost in spending will continue to impact the savings rate in a negative way.
Over 400 of the S&P 500 companies have already reported, representing 86% of the market capitalization. Smaller companies are left to close out the season. So far, reported sales growth has been 5.3%, but earnings are down 4.9%. Quite the difference, but not unexpected. Energy and Industrial companies showed the most growth, with Consumer Discretionary showing the biggest drop. High inflation is goosing the top line revenue metrics but hurting margins as volumes go down. The number of “beats” has been below recent trends but not out of the ordinary.
The post-Covid sales/earnings bounce back is now behind us. Supply chains are getting repaired, especially as China reopens and helps the semiconductor chip, auto and apparel industries. A more normalized trend line would be welcome news following extraordinary spikes since Covid impacted the globe:
Low Unemployment is a Negative Lagging Indicator:
A little counter intuitive to say the least. One would think that having full employment, rising wages and stability in the jobs market would be great news. It is for those employed, but history says the stock market is less than enthused. This goes back to the old adage that good news gets priced in well before the data arrives. On top of that, once economies are fully employed, it allows the proverbial punch bowl to get pulled. Tighter monetary conditions arrive in order to quell inflation. In the opposite scenario, like the post-Covid period when much of the world was not working, money is pumped into the system.
Here are some historical returns (email for a cleaner version: firstname.lastname@example.org):
Our current unemployment rate of 3.4% falls squarely in the lower expected return bucket of less than 4%. At the peak of Covid (when the sky was falling and no one wanted to buy stocks), unemployment was nearly 15%. That was the time to pound the table and buy stocks. Nothing here is obvious to a casual follower of earnings and profits. However, one must answer the question, how much better can it get?
Futures are now pricing in possibly three more rate hikes and zero cuts in 2023. Inversions have always mattered…eventually. Covid threw a wrench into everyone’s “normal” economic cycles, creating a rolling recession in various industries. Years of demand for PC’s, smartphones, home furnishings and even pools were pulled forward during lockdowns. On the other end, spending on new cars, vacations, dining out and many other services were pushed out. Savings accounts boomed during the pandemic and are still elevated for many. While economists’ models point to a recession a few months after almost every inverted yield curve, this post-Covid world is not like others. As noted, first quarter GDP estimates are rocketing higher after only one month of data. All signs point to a soft or even the no-landing scenario for now.
Our Fed is laser focused on a tight labor market. Their belief is that inflation will get back to 2% without some pain here. Less employed = less money to spend = lower prices. Only then will they attempt to normalize interest rates, as in pivot. Looking back at times when the Fed does finally pivot shows some tough markets. In summary, get used to tighter lending standards and higher interest rates.
Junk is having its day in the sun, but all of the above continues to point to sticking with companies that have high-quality, clean balance sheets, low debt levels, high free cash flows, predictable earnings streams and are gaining market share. We have no idea what 5% interest rates mean in today’s high debt world. The bear market could be over, but history is fraught with a not-so-great period…somewhere down the road. For now, data looks solid, buybacks are accelerating, and consumers are willing to spend. Enjoy the good times but do not get out over your skis.
Michael Jordan, and his ~$2 billion net worth, turns 60 today. Ed Sheeran is 32, and Joseph Gordon-Levitt is now 42. Larry the Cable Guy is 60, and the Director of Armageddon, The Rock, Bad Boys and Pearl Harbor, Michael Bay, turns 58 today.
James Vogt, 610-260-2214