Stocks fell yesterday in a relatively quiet mixed session. While the Dow fell a full percentage point, other leading averages fell much less. The main culprit was Goldman Sachs whose disappointing earnings report sent its shares down over 6%. That accounted for 40% of the Dow’s decline by itself. Elsewhere, the bond market was quiet, oil prices rose above $80 once again, and the rest of the economic data was unsurprising.
We are entering the heart of earnings season, a period where management comments will dominate what markets do, at least over the next two weeks until a distinct pattern takes hold. Yesterday was a case in point. While Goldman dropped over 6%, its main rival, Morgan Stanley saw its stock rise almost 6% as earnings beat expectations. Both companies had miserable performance related to IPOs and capital raising. Morgan has more of a retail focus, which helped. Goldman’s retail focus is almost entirely within its former Marcus brand aimed at consumer banking and credit cards. It has been a loser since Goldman formed it and a big drag on earnings. Thus, much of what happened yesterday, at least with these two enterprises, was company specific. Nonetheless, we are in that moment of the month when optimistic outlooks lift stocks and pessimism leads to losses. Yesterday, the balance was negative and stock prices fell.
Nowhere was the picture more mixed than in the technology sector. There is a lot of rotation going on. Growth businesses of the last decade, like social media, digital advertising, Internet retailing and the emergence of the cloud are giving way to a focus on generative artificial intelligence (AI). A relatively new app, ChatGPT, developed by OpenAI, a private company with very large backers including Microsoft#, has caught everyone’s attention. It was even a cover story in yesterday’s New York Times relative to the ability of the user of ChatGPT to write best-in-class term papers in college.
ChatGPT is intriguing, but it isn’t perfect. Few early disruptive apps are, but it is clearly a seed to something special, an app that can save massive amounts of time in writing stories or developing new computer code. In a sense, ChatGPT is like autonomous driving or using voice on your iPhone to write messages. It is highly accurate but not perfect. If not used correctly and properly, these apps are certain to cause embarrassing blunders. But the beauty of the software is that it can learn from its mistakes. Dictation software adapts to your voice and remembers complex words it couldn’t understand the first time. Autonomous driving makes fewer mistakes but still makes enough to keep it out of the mainstream.
ChatGPT is still not ready for prime time. Indeed, there are other similar products out there vying for leadership. ChatGPT could win, given its early start and big backing, or it could become the next MySpace or AOL, but what isn’t too early to tell is that generative AI is for real. While the emerging leadership app is still uncertain, what isn’t uncertain is that the applications will require enormous computing power and very sophisticated software. Thus, companies making the most powerful chips and the software to compose the AI code are emerging as tech leaders, at least for now. Note the names that were either born or nascent at the turn of the century just over 20 years ago. Names like Google, Facebook and Tesla today, are top 10 companies by market cap. Most weren’t even public a quarter century ago. I see the same thing emerging today. Generative AI is probably just one example. The use of mRNA to develop Covid vaccines so quickly along with CAR T-cell therapy will open doors to new drugs to treat and cure everything from major forms of cancer to orphan diseases caused by genetic disorders.
Those are some of the opportunities. Others exist in simple blocking and tackling. We have seen major management shifts recently at Fedex# and Disney#. Both appear to have drifted away from their main focus. Both seemed to be spending indiscriminately. Both are now in the process of massive reorganization with a focus on rationalizing cost. Each is learning there is a massive opportunity to improve the income statement. Whether they succeed or not is still an open question. In tech land, look at Amazon# or Meta Platforms#. At Amazon, founder Jeff Bezos famously spent heavily on new or acquired ventures. He was always spending for the future, one that got incrementally bigger over time, but growth has slowed. Internet retailing is great but it is becoming mature and Amazon has a lot more competitors than it did just a few years ago. Major brands, like Nike, are selling online directly, avoiding Amazon the way Lululemon and others avoid the department stores. New CEO Andy Jassy has his hands full rationalizing expenses. Similarly, at Meta Platforms, Mark Zuckerberg became famous taking big risks. His purchase of Instagram may have been his best single move after deciding the mobile app, not the desktop computer, was where social media would thrive, but it has a huge competitor today in TikTok. Its enormous spending on the metaverse has investors concerned. It is now in the process of reining in the spending and focuses more attention on beating TikTok. Again, it will be up to investor, to decide the ultimate success.
As for the rest of the economy, it is still unclear whether or not there will be a recession. At the moment Fed Funds futures say there is a 75% chance of a second-rate hike in March of 2023. The employment and CPI reports covering December showed a slowdown in job growth, less wage pressures, and much slower increases in consumer prices. There will be two more employment reports and two more CPI reports before the March FOMC meeting. Those 75% odds could come down dramatically if the trends of the past three months continue through February. At the moment, I see little reason why they shouldn’t. Thus, it could be that the pending increase (which might be unnecessary but is baked in the cake) might be the last. It may be too late to avoid a recession. If one does develop, and inflation keeps dropping, watch for the Fed to start to move rates back down toward neutral in the second half of this year. I am aware that Fed officials, in unison, say that won’t happen this year and the target rate is headed for 5% or higher. But Fed officials are notoriously bad predictors of the future beyond the next six weeks, the time gap between FOMC meetings. One is simply much better off ignoring their long-term guidance and interpreting the data.
Generally, the data has been good for stocks. The rally so far in January may, however, be a bit too fast. Hence, days like yesterday. Near term, the economic news will be rocky as the impact of prior rate increases is felt, but the clouds on the horizon are getting a bit thinner. Long term interest rates are coming down. Housing costs, the biggest component to inflation, are moderating. Wage demands remain strong but not as strong as just a few months ago. Signing bonuses are now rare. Retention payments are becoming less necessary. On the inflation front, all evidence points to movement in the right direction even knowing that gasoline prices will likely rise again as winter fades and summer driving season approaches.
In the stock market, early cycle companies are moving well off their lows. These include homebuilders, retailers, and banks. Stocks of companies that led last year, including consumer staples, drug manufacturers, and energy names are holding their ground but not leading the January rally. A big part of the rally is centered within the “dead cat bounce”, names that fell 80% or more from their frothy peaks. Be careful here. Some of these companies will never thrive. A few will ultimately disappear and fade away altogether. And yes, a few will rebound and be for real, but only a few. Once the current bounce is over, fundamentals will matter again. Remember the “meme” stocks, names like AMC, GameStop, and Bed Bath & Beyond? These stocks quickly have risen 40-100% from their lows, but don’t be fooled. Bed Bath & Beyond is most likely headed for bankruptcy and AMC is moving in that direction. Each could raise money and buy time but those retail stores and theatres are money losers unlikely to turn around.
In summary, skies are brightening but it is still mostly cloudy. Valuations suggest headwinds remain. Leadership within markets is rotating. One can’t simply go back to what worked in 2019 or 2021. There are radical changes ahead in technology, medicine and even the mundane auto industry. Retailing tomorrow will be hybrid. Successful companies will need both a physical and online presence in some fashion. We will carry less cash and even change the way we use our spare time. Pickleball anyone? It will be a great new adventure, hopefully a profitable one.
Former NY Ranger great Mark Messier is 62 today. Kevin Costner turns 68.
James M. Meyer, CFA 610-260-2220