Attention on Wall Street is shifting away from guessing future interest rates to the distinct possibility of an economic downturn. And that is encouraging investors to reward the strong and punish the weak. This is causing increasing divergences between the performance of different stocks within the same index or even the same sector.
Winners offsetting losers is giving the impression of a quiet market not really going anywhere when you look down on it from an index level, but there is a lot going on under the surface.
We are also seeing bonds finally beginning to return to their historically traditional role as having a low or even sometimes reverse correlation with stocks. This was very not the case in 2022 which is why it was such a uniquely disastrous year for portfolios with diversified stock/bond allocations as everything took a dive at the same time which almost never happens for any extended period.
House Republicans and the White House are on a high-speed debt ceiling collision course with each side betting the other will blink before impact. Both camps seem to be counting on a portfolio-busting investor meltdown to do their dirty work for them when they eventually reach a face-saving compromise in the 59th minute of the eleventh hour to dodge a default. That way, they can turn around to their respective bases and say that, although they did their very best to screw over the other side, those pesky financial markets forced their hands and that, in the end, they took a decision that was in the best interests of the country. So icky.
Meantime, the picture will likely emerge on the world stage of the United States as a largely dysfunctional quasi-banana republic shooting itself in the foot and no longer worthy of a position of a leader and steward of global markets and the worldwide economy. Lots of wry smiles in Beijing, I’m thinking.
During a week in which you’d think his attention ought to be elsewhere, potential presidential candidate Donald Trump still managed to find time to hop aboard the default express, embracing the willingness (some might say eagerness) of many House Republicans to risk a US debt default as a weapon to extract political concessions.
Speaker Kevin McCarthy also doubled down on the strategy last week, saying after a breakdown of talks with the President that the consensus among Republicans is to “keep the pressure on POTUS”. This stance is not impressing JP Morgan CEO Jamie Dimon who, along with his Goldman Sachs counterpart, preached to the choir and sent a letter to US Treasury Secretary Janet Yellen calling for an urgent and immediate increase to the debt limit.
The whole Congressional dance of death is starting to affect consumer sentiment, as represented by the latest monthly Index of Consumer Sentiment released last week, which is quickly turning sour as Americans become significantly more concerned about the health of the economy and what is looming on the horizon.
Consumer prices rose less than expected on an annual basis in April, raising optimism that stubbornly high inflation is beginning to moderate. The Consumer Price Index (CPI) measure of retail inflation was up 4.9% year-over-year, down from 5.0% in March and below economists’ forecasts. That was the lowest level for the CPI in two years. The monthly gain of 0.4% was in line with expectations. It was the 10th-straight month of lower annualized inflation, from a peak of above 9% last summer.
The CPI numbers were confirmed by the Producer Price Index (PPI) measure of wholesale inflation affecting manufacturers which was released the next day, and was pretty much in line with expectations, showing its lowest reading since January 2021.
While inflation is inching towards the Federal Reserve's 2% target, it may be a while before we get there. New York Fed President John Williams said this week that it could take as long as two years before we see inflation back where the Fed needs it to be.
Nevertheless, the two inflation reports seem to have done little to change the market’s view that the Fed will leave interest rates unchanged next month (still hovering around a 90% probability) and it’s unanimous; quite literally 100% of futures market participants believe that the Fed will have been forced to cut rates by the end of the year (see FEDWATCH INTEREST RATE PREDICTION TOOL below) even though the Fed insists that it won’t do such a thing.
Regional bank instability continued as PacWest (PACW) announced that it had lost 10% of its deposits in just a two-day period and the stock promptly fell 22% in the blink of an eye. To be clear, don’t listen to the clueless 2008 truthers on Fintok - the problem is not an insolvency one this time where the public will necessarily lose their deposits, it’s a macro-economic one resulting from a likely widespread reduction in bank capital being made available for businesses (credit contraction, as it is known on Wall Street) because of inevitably increased regulatory and FDIC insurance costs.
The likely Fed pause, better-than-feared Q1 2023 earnings and most of the May economic data so far have all been kind of okay and generally a somewhat muted net positive for stocks. But most of these factors are also already priced in and none of the major issues that could cause a sharp market decline (a nasty recession, inflation stickiness, more regional bank issues, debt ceiling chaos etc.) have yet been eliminated.
In other words, all that’s happening is that already-existing expectations are being mostly met and validated. It’ll take a substantial improvement in multiple market influences to push stocks meaningfully higher from here. Meanwhile the risk to the downside brought about by any kind of disappointment remains elevated.
OTHER NEWS ..
We’re happier, especially the guys .. The Wall Street Journal reported last week that job satisfaction among Americans hit a 36-year high in 2022, reflecting two effects of the tight pandemic labor market: the quality of jobs improved as wages and work flexibility increased and workers moved into positions that were a better fit.
Last year, over 62% of U.S. workers said they were satisfied with their jobs, according to new data from the Conference Board, up from 60% in 2021 and 57% in 2020. The business-research organization polled workers on 26 aspects of work and found that people were most content with their commutes, their co-workers, the physical environment of their workplace and job security.
Among the happiest workers: people who voluntarily switched jobs during the pandemic and individuals working in hybrid roles with a mix of in-person and remote work. Men’s satisfaction was higher than women’s in every component, especially in areas such as leave policies, bonus plans, promotions, communication and organizational culture.
Icahn follow up .. In last weekend’s report, I mentioned Hindenberg Research’s report targeting Icahn Enterprises (IEP). Indeed, the research firm has since doubled down on its IEP accusations with even more criticisms of the company and its larger-than-life founder Carl Icahn. Maybe someone over at the US Attorney’s Office for the Southern District of New York read their copy of Angles last Sunday as it contacted IEP last week asking for information about the value of its assets, corporate governance, dividends and other topics. IEP said in a filing that it is cooperating with the investigation and doesn’t believe it will have a significant impact on the firm.
Hmmm, I’m not so sure about that, Carl - the firm’s share price straight away dropped by 15% when news of the probe broke and ended the week over 76% below its all-time high.
Biking to oblivion? .. Shares of Peloton Interactive (PTON), priced above $167 as recently as 2021, closed last week below $7 after being told to recall over two million exercise bikes following reports of injuries caused by seats breaking during use, the US Consumer Product Safety Commission (CPSC) said on Thursday. The recall piles more pressure on PTON as the company has already been dealing with massively waning demand for its high-end fitness equipment amid an uncertain economy.
UNDER THE HOOD ..
Consider that Apple (AAPL) and Microsoft (MSFT), the top two of the 500 companies in the market capitalization-weighted S&P 500, have a 10% weighting in the index while representing just 0.4% of the component stocks.
The biggest five - Apple, Microsoft, Amazon (AMZN), Nvidia (NVDA) and Alphabet/Google (GOOGL) - while representing only 1% of the number of component stocks in the index, now carry more than a 20% weighting in the performance of the index as a whole and these stocks are moving in an entirely different direction than the greater universe of sliding Mid Cap and Small Cap stocks (see EXPLAINER: FINANCIAL TERM OF THE WEEK).
Therefore, it should be of no surprise that while the S&P 500 recently traded close to its own February high, huge parts of the market have been in meaningful decline since the end of January. The same is true for the NASDAQ Composite Index, where AAPL and MSFT alone weigh in at a combined 22% of the index. And if these monster names begin to falter as a result of profit-taking in a general downturn or even any kind of idiosyncratic problems, that will be bad news bears for the indexes.
Things can change, of course, but right now the vast majority of technical evidence is pointing to a rapidly fading bear market rally rather than to a new bull market.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
Q1 2023 earnings season continues this week with retailers taking center stage. Highlights will be Home Depot, Walmart, Target, Alibaba, TJX, Ross Stores, Cisco, Applied Materials, Deere and Take-Two Interactive.
The highlight of a relatively light week of economic data will be Retail Sales which is forecast to rise 0.7% from a month earlier, versus a decline of 0.6% last time out.
We’ll also get the Leading Economic Index and several housing indicators including the Housing Market Index, New Residential Construction and Existing Home Sales data.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.35%
(one week ago: 6.39%, one month ago: 6.27%, one year ago: 5.30%)
Data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
US INVESTOR SENTIMENT (outlook for the upcoming 6 months) ..
↑Bullish: 29% (24% a week ago)
↔ Neutral: 29% (31% a week ago)
↓Bearish: 42% (45% a week ago)
Net Bull-Bear spread: ↓Bearish by 13 (Bearish by 21 a week ago)
Data courtesy of: American Association of Individual Investors (AAII).
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
US TREASURY INTEREST RATE YIELD CURVE ..
The interest rate yield curve remains “inverted” (i.e. most shorter term interest rates are higher than longer term ones) with the highest rate (5.79%) being paid currently for the 1-month duration and the lowest rate (3.45%) for the 7-year.
The closely-watched and most commonly-used comparative measure of the spread between the 2-year and the 10-year last week rose from 0.48% to 0.52%, indicating an overall steepening of the curve over the last five days.
The curve has been inverted since July 2022 based on the 2-year vs. the 10-year spread. Historically, an inverted yield curve has been regarded as a leading indicator of an impending recession, with shorter term risk deemed to be unusually higher than longer term.
Data courtesy of ustreasuryyieldcurve.com as of Friday.
FEDWATCH INTEREST RATE PREDICTION TOOL ..
Where will interest rates (Fed Funds rate, currently 5.125%) be at the end of 2023?
↑ Higher than now .. 0% probability
(one week ago: 0%, one month ago: 0%)
↔ Unchanged from now .. 0% probability
(one week ago: 0%, one month ago: 1%)
↓ Lower than now .. 100% probability
(one week ago: 100%, one month ago: 99%)
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.125%) on June 14th after its next meeting?
↑ 0.25% increase .. 12% probability
(one week ago: 0%, one month ago: 6%)
↔ No change .. 88% probability
(one week ago: 93%, one month ago: 67%)
↓ 0.25% cut .. 0% probability
(one week ago: 7%, one month ago: 27%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Communication Services (two biggest holdings: Alphabet/Google, Meta/Facebook) - up 2.4% for the week
- Last week’s worst performing US sector: Energy (two biggest holdings: Exxon-Mobil, Chevron) for the second week in a row - down 2.2% for the week
- The proprietary Lowry's measure for US Market Buying Power is currently at 132 and fell by 7 points last week and that of US Market Selling Pressure is now at 165 and rose by 4 points over the course of the week.
- SPY, the S&P 500 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line with a RSI of 53**. SPY ended the week 13.8% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line with a RSI of 60**. QQQ ended the week 19.6% below its all-time high (11/19/2021).
- VIX, the commonly-accepted measure of expected upcoming stock market risk and volatility (often referred to as the “fear index”), implied by S&P 500 index option trading, ended the week 0.2 points lower at 17.0. It remains below its 50-day and 90-day moving averages and below its long term trend line.
** RSI (Relative Strength Index) above 70: technically over-bought, RSI below 30: technically over-sold
ARTICLE OF THE WEEK ..
Stocks for the short term? Nooooooo!
EXPLAINER: FINANCIAL TERM OF THE WEEK ..
A weekly feature using information found on Investopedia to try to help explain Wall Street gobbledygook (may be edited at times for clarity).
Market capitalization (market cap) refers to the total dollar market value of a company's outstanding shares of stock. The investment community uses this figure to determine a company's size instead of sales or total asset figures. In an acquisition, the market cap is used to determine whether a takeover candidate represents a good value or not to the acquirer.
Understanding what a company is worth is an important task and often difficult to quickly and accurately ascertain. Market capitalization is a quick and easy method for estimating a company's value by extrapolating what the market thinks it is worth for publicly traded companies. In such a case, simply multiply the share price by the number of available shares.
After a company goes public and starts trading on the exchange, its price is determined by supply and demand for its shares in the market. If there is a high demand for its shares due to favorable factors, the price would increase. If the company's future growth potential doesn't look good, sellers of the stock could drive down its price. The market cap then becomes a real-time estimate of the company's value.
The formula for market capitalization is:
Market Cap = Current Share Price * Total Number of Shares Outstanding
For example, a company with 20 million shares selling at $100 a share would have a market cap of $2 billion. A second company with a share price of $1,000 but only 10,000 shares outstanding, on the other hand, would only have a market cap of $10 million.
A company's market cap is first established via an initial public offering (IPO). Before an IPO, the company that wishes to go public enlists an investment bank to employ valuation techniques to derive a company's value and to determine how many shares will be offered to the public and at what price.
For example, a company whose IPO value is set at $100 million by its investment bank may decide to issue 10 million shares at $10 per share or they may equivalently want to issue 20 million at $5 a share. In either instance, the initial market cap would be $100 million.
Given its simplicity and effectiveness for risk assessment, the market cap can be a helpful metric in determining which stocks you are interested in, and how to diversify your portfolio with companies of different sizes.
Large-cap companies typically have a market capitalization of $10 billion or more. These companies have usually been around for a long time, and they are major players in well-established industries. Investing in large-cap companies does not necessarily bring in huge returns in a short period of time, but over the long run, these companies generally reward investors with a consistent increase in share value and dividend payments. Examples of large-cap companies—and keep in mind that this is an ever-changing sample—are Apple Inc., Microsoft Corp., and Google parent Alphabet Inc.
Mid-cap companies generally have a market capitalization of between $2 billion and $10 billion. Mid-cap companies are established companies that operate in an industry expected to experience rapid growth. Mid-cap companies are in the process of expanding. They carry an inherently higher risk than large-cap companies because they are not as established, but they are attractive for their growth potential. One example of a mid-cap company is Eagle Materials Inc. (EXP).
Small-cap companies generally have a market capitalization of between $300 million to $2 billion. These small companies could be younger and/or they could serve niche markets and new industries. These companies are considered higher-risk investments due to their age, the markets they serve, and their size. Smaller companies with fewer resources are more sensitive to economic slowdowns.
As a result, small-cap share prices tend to be more volatile and less liquid than more mature and larger companies. At the same time, small companies often provide greater growth opportunities than large caps. Even smaller companies are known as micro-cap, with values between approximately $50 million and $300 million.
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