06/12/2022. Catch up with all you need to know from the entire previous week in financial markets in less than ten minutes every Sunday by reading or listening to my weekly market review.
Last week saw some damaging backsliding for two of the three primary market drivers (how hawkish the Fed needs to be and China lockdowns) and no meaningful sign of progress in the third (Ukraine).
After the market indexes kind of meandered around without much direction early in the week, a sense slowly began to build that Friday’s inflation number might end up being more troubling than had been previously assumed. This was perhaps triggered by a second warning in the space of three weeks from Target (TGT) on Tuesday that the company would be forced into cutting prices — and profits — to pare down the retailer's excess inventory of goods that are not selling and added that "decisive" action was needed to keep these problems from lingering until later in the year.
Remember, the prevailing view until recently had been that we may well have hit peak inflation in April and that May’s data release would finally signal a beginning of the end of these current spiked inflation levels. But doubts began to emerge as the week went on.
The fears proved well-founded. On Friday morning, the Consumer Price Index (CPI) measure of retail inflation came out and showed no such positive signs. It rose by 1.0% in May alone and 8.6% from May 2021, the highest since Olivia Newton John was getting physical with everyone in December 1981. These numbers were even worse than in April and also higher than consensus expectations. Surging prices for energy, housing, and food contributed the most to the increase, with the energy index alone jumping 3.9% last month after actually declining in April. Core CPI, which excludes more volatile food and energy prices, climbed 0.6% in May, and was up 6.0% from last year, also higher than expected.
Obviously, these numbers aren't convincing anyone that things are getting any better. Peak inflation is very much not here – not yet, anyway. The Fed has told us all that it is going to continue stomping on the brakes but the prices of essentials like shelter, meat, bread, eggs, gas etc. with relatively inelastic demand (and, notably, which interest rate adjustments don’t really help to cool), are still rocketing higher with no end in sight. Additionally, the ongoing war in Ukraine pretty much rules out a material fall in food and energy prices any time soon.
The issue is whether we are going to get an old-fashioned “bust” before short term rates get raised high enough to start having an effect on inflation. The previously-trending idea of a Fed “pause” after 0.50% hikes at each of its two upcoming meetings next week and in July seems to now be pretty much in tatters.
Inevitably, the yield on the 10-year Treasury note jumped back above 3% to its highest level in a month, but the closely-watched spread between the 10 year rate and the 2 year rate narrowed sharply and is now less than 0.1%. Many believe that the tighter this spread gets (and indeed, ultimately crosses over whereby the 2 year rate becomes higher than the 10 year), the more inevitable a recession becomes.
At the same time, the University of Michigan's Consumer Sentiment Index hit the lowest level in its history as Americans expressed significant concerns about rising prices, especially at the gas station, with 46% of respondents attributing their negative views about the economy to inflation.
Because markets had somehow swallowed the story of the arrival of a peak in both inflation and the Fed’s hawkishness and already priced it in, stocks had the shit kicked out of them on Friday. The downward path of least resistance was not helped by news out of China. Shanghai's government said it would place a district in the southwestern part of the city under restrictions for mandatory mass COVID testing, starting Saturday. Then another outbreak of COVID was reported near Beijing on Thursday.
Further reducing the number of places to hide, the European Central Bank announced it will raise interest rates next month for the first time in eleven years and could make an even bigger hike after that in an effort to slow soaring inflation in the EuroZone. It is also ending its bond purchase program put in place during the COVID crisis to boost the economy. Worth bearing in mind: the first hike will likely raise rates to zero.
The bottom line is that inflation has to not only peak but also show evidence of starting to meaningfully recede for the skies to begin to clear and after Friday’s data, no-one has any idea when this will happen. The Fed has made it clear that it regards inflation as a far bigger enemy than recession and will definitely risk the latter in trying to crush the former. Each time the inflation data shows no relief, the Fed is going to further double-down on its mission.
Doing the splits .. Amazon (AMZN) split its stock this week stock at a rate of 20:1. (see FINANCIAL TERM OF THE WEEK below) and Tesla (TSLA) announced that it would do the same, but at a rate of 3:1. The forward stock splits will increase the total number of outstanding shares in the company while at the same time reducing the share price by the same multiple.
As a result, while eligible shareholders with shares at the time of the split will receive more shares, the total dollar value and cost basis of their positions will not change. A stock split neither creates nor destroys value. The total amount of pizza doesn’t change whether the pie is cut into four slices or eight.
Speculation is that the move is primarily designed to make it easier for these firms to be incorporated in the calculation of Dow Jones Industrial Average of just thirty stocks, which, uniquely (and ridiculously!) among stock market indexes, is a price-weighted average that would be blown out by the inclusion of these stocks at their current elevated prices.
Stores filled with the wrong items? .. Shoppers have shifted spending from the casual clothes and home items that had been in demand during the height of the pandemic, catching most retailers off guard and leaving them with excess goods that now need to be marked down so they can be moved. Target (TGT) wasn’t the only retailer to point this out. Joggers are piled up at Gap (GPS), Macy’s (M) has too much activewear and Kohl’s (KSS - an apparent target last week of a takeover by the owners of the Vitamin Shoppe) is full of fleece. But Macy’s said markdowns to clear the excess inventory would weigh heavily on profit margins, and warned of higher promotional levels throughout the industry as other retailers do the same.
Credit card worries .. There is growing concern about rapidly increasing credit-card usage by consumers amidst rising interest rates. As rates go up, credit-card companies charge even more for balances carried by consumers. Those levels are usually extremely high since, unlike mortgages and car loans, there is no collateral involved. The average interest rate currently being charged is 16.7%. That's the highest level in two years.
The latest revision of first-quarter gross domestic product showed US Household Disposable Income is down 5.5% compared with the same period a year ago. That points to rapidly shrinking spending power for American households.
This is a potentially toxic combo of circumstances as disposable income will shrink further and faster as higher debt needs to be serviced at higher interest rates. If this dynamic doesn't change, it could easily help push the economy into a recession.
Under The Hood:
What technical indicators should we be looking out for when it comes to signs that the market may have bottomed out?
The ideal setup for a lasting bottom is usually a fully oversold market where anything and everything is indiscriminately dumped by investors resulting in the complete exhaustion of Supply, immediately followed by a powerful and sustainable reversal that takes important core indicators back above recent highs.
Further evidence that the primary trend is actually changing from negative to positive may be found in this reversal being confidently led by the “risk-on” portions of the market, such as smaller stocks and the NASDAQ. Relative outperformance from traditionally aggressive sectors, such as technology and consumer discretionary, would provide further confidence in any rally rather than the leaders being from the more defensive sectors, such as utilities, consumer staples and healthcare.
Unfortunately, none of this is happening. We are still experiencing pretty high Relative Strength Indicator (RSI) levels (see LAST WEEK BY THE NUMBERS below) demonstrating a distinct lack of the oversold condition associated with the kind of capitulation that usually precedes a true rebound rally. Persistent RSI readings of below 30 or even below 25 are usually required to trigger such capitulation and current readings (even after falling hard at the end of last week) are still closer to 40.
When short term rallies do occur, any leadership provided by the important aggressive sectors (particularly technology) usually fizzles out very quickly, rarely lasting more than a day or two before resuming its role as the market’s punching bag as happened at the end of last week.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
The upcoming week’s calendar ..
This week will be dominated by the interest rate decision from the Federal Open Market Committee (FOMC) after its two-day meeting ends on Wednesday. Chairman Jerome Powell will answer questions from the press that afternoon. It’s almost completely priced in that the FOMC will raise its Fed Funds target by half a percentage point, to a range of 1.25% to 1.50%. Any deviation from this will be seismic to markets.
Their projections for economic growth, the unemployment rate, inflation, and future interest rates will give economists and investors greater insight into the committee's possible next moves.
A light week for earnings reports features Adobe, Kroger and Oracle with The New York Times and NextEra Energy hosting investor days.
The measure of wholesale inflation, Producer Price Index (PPI) comes out on Tuesday. It is expected to have climbed 0.7% in May, for a 10.8% year-over-year increase with the non-food and -energy Core rate rising 0.6% and 8.7% respectively.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months):
↑Bullish: 21% (down from 32% the previous week)
→Neutral: 32% (up from 31% the previous week)
↓Bearish: 47% (up from 37% the previous week)
Net Bull/Bear spread .. ↓Bearish by 26 (Bearish by 5 the previous week)
Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Bull-Bear spread: Bullish by 8
Source: American Association of Individual Investors (AAII). All numbers rounded.
LAST WEEK BY THE NUMBERS:
- Last week’s best performing US sector: Energy (two biggest holdings: Exxon Mobil, Chevron) once again - down 1.0%
- Last week’s worst performing US sector: Financials (two biggest holdings: Berkshire Hathaway, JP Morgan Chase) - down 6.9%
- The NASDAQ-100 did a little worse than the S&P 500
- The US and International Developed Markets both hugely underperformed Emerging Markets
- Large Cap performed worse than Mid or Small
- Growth underperformed Value
- The proprietary Lowry's measure for US Market Buying Power is currently at 176 and fell by 11 points last week while that of US Market Selling Pressure is at 186 and rose by 6 points over the course of the week
- SPY, the S&P 500 ETF is well below both its 50-day moving average and its 90-day and also remains below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 38**. SPY ended the week 18.4% below its all-time high (01/03/2022)
- QQQ, the NASDAQ-100 ETF, is well below both its 50-day moving average and its 90-day and also remains below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 39**. QQQ ended the week 28.5% below its all-time high (11/19/2021)
** RSI readings range from 0-100. Readings below 30 tend to indicate an over-sold condition, possibly primed for a technical rebound and above 70 are often considered over-bought, possibly primed for a technical decline
- VIX, the accepted measure of anticipated upcoming stock market risk and volatility implied by S&P 500 index option trading (often referred to as the“fear index”) ended the week higher at 27.8 and is now above both its 50-day and 90-day moving averages and well above its long term trend line
ARTICLE OF THE WEEK:
Each week I'll link to an interesting article I have come across recently.
With regular reports of massive hedge fund losses and closures, Josh Brown reminds us how the ups simply don’t happen without the downs.
FINANCIAL TERM OF THE WEEK:
A weekly feature using information found on Investopedia (may be edited at times for clarity).
A stock split is a corporate action in which a company issues additional shares to shareholders, increasing the total by the specified ratio based on the shares they held previously. Companies often choose to split their stock to lower its trading price to a more comfortable range for most investors and to increase the liquidity of trading in its shares.
Most investors are more comfortable purchasing, say, 100 shares of a $10 stock as opposed to 1 share of a $1,000 stock, even though arithmetically there is no difference. So when the share price has risen substantially, many public companies end up declaring a stock split to reduce it. Although the number of shares outstanding increases in a stock split, the total dollar value of the shares remains the same compared with pre-split amounts, because the split does not make the company more valuable.
The most common split ratios are 2-for-1 or 3-for-1 (sometimes denoted as 2:1 or 3:1). This means for every share held before the split, each stockholder will have two or three shares, respectively, after the split. Having said that, a company's board of directors can choose to split the stock by any ratio. For example, a stock split may be 2:1, 3:1, 5:1, 10:1, 100:1, etc. A 3:1 stock split means that for every one share held by an investor, there will now be three. In other words, the number of outstanding shares in the market will triple.
On the other hand, the price per share after the 3:1 stock split will be reduced by dividing the old share price by 3. That's because a stock split does not alter the company's value as measured by market capitalization.
Special considerations .. Market capitalization is calculated by multiplying the total number of shares outstanding by the price per share. For example, assume XYZ Corp. has 20 million shares outstanding and the shares are trading at $100. Its market cap will be 20 million shares x $100 = $2 billion.
Let's say the company’s board of directors decides to split the stock 2:1. Right after the split takes effect, the number of shares outstanding would double to 40 million, while the share price would be halved to $50. Although both the number of shares outstanding and the market price have changed, the company's market cap remains unchanged at (40 million shares x $50) $2 billion.
A stock split isn't worthless, but it doesn't impact the fundamental position of a company and therefore doesn't create additional value. Some compare a stock split to slicing a pizza pie. The total amount of pizza is the same whether it has been cut into 4 slices, 8 slices or 16 slices. And the number of slices also has no effect on whether the pizza tastes good or not.
Reverse stock splits .. A traditional stock split is also known as a forward stock split. A reverse stock split is the opposite of a forward stock split. A company carrying out a reverse stock split decreases the number of its outstanding shares and increases the share price proportionately. As with a forward stock split, the market value of the company after a reverse stock split remains the same.
A company that takes this corporate action might do so if its share price had decreased to a level at which it runs the risk of being delisted from an exchange for not meeting the minimum price required for a listing. Certain mutual funds may not invest in stocks priced below a preset minimum per share. A company might also opt for a reverse split to make its stock more appealing to investors who may perceive higher-priced shares as more valuable.
This material represents an opinionated assessment of the market environment based on assumptions at a specific point in time and is always subject to change. No warranty of its accuracy is given. It is not intended to act as a forecast of future events, nor does it constitute any kind of a guarantee of any future results or outcomes. The material contained herein is insufficient to be exclusively relied upon as research or investment advice. The user assumes the entire risk of any actions taken based on the information provided in this or any other Anglia Advisors post or other communication.
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