By David Nelson, CFA
As we head into week 20 for 2022 there’s one question on every investor’s mind:
Was Friday’s surge off the bottom the beginning of something sustainable or just a one day cease fire in a war that has wiped $7 Trillion in the S&P 500 alone? First, from a technical perspective nothing has really happened yet. When the 200 day rolls over it becomes harder and harder to take out the overhead supply and the market is looking at months of repair.
(Click on chart to expand)
The good news is that the bottoming process and it is a process has likely already started. (No, it doesn’t mean the market can’t go lower)
Bloomberg Data
The second and probably more important is that some pockets of the market are weathering the storm as the selling has been concentrated in NASDAQ favorites many with little in the way of fundamentals as investors were myopically focused on revenue growth alone. In a world where the Fed has no choice but to tighten financial conditions top line growth with little flowing through to the bottom line just isn’t going to cut it.
Bubbles Bursting (Click on chart to expand)
Data by FactSet
But even here there are signs of capitulation. Post bubbles some of the most popular and overvalued stocks and or asset classes often bottom down about 80-90%. Even the poster child of excess and irresponsible portfolio management the ARKK Innovation Fund (ARKK) at its recent bottom was down -78% from its 2021 high.
Peloton (PTON) a stay-at-home favorite crashed down over -90%. Chinese internet stocks represented by the Krane’s shares China Internet ETF (KWEB) is off more than -80% from last year’s highs.
Dot.Com Bust (Click on chart to expand)
Data by FactSet
For some context, it’s instructive to look at past bursting bubbles. One I remember vividly because it was my first as a newly minted Money Runner working for Lehman, was the dot.com bust. The catalysts are different, but the end result was the same. At the bottom Amazon (AMZN) and Cisco (CSCO) were down -94% and -87% respectively. At the highs CSCO traded at 128 x earnings. Today, it is just 13x and considered by many a value stock.
Last week we discussed Apple (AAPL) as the last domino of the popular mega cap FAANMG trade also including FB, AMZN, NFLX, MSFT and GOOGL. Apple couldn’t hold the line last week and it too is now underperforming the S&P 500.
Year to Date Winners vs Losers (Click on table to expand)
Bloomberg Data
Every war has its winners and losers and this one is no different. Stocks generating above average Free Cash Flow Yields and paying dividends have held up well and in some cases up dramatically year to date. Large Cap Value and the Equal Weighted S&P 500 have both outperformed the broad market which is heavily weighted with large cap secular growth stocks.
(Click on chart to expand)
Bloomberg Data
As you can see in the valuation chart the equal weighted index is starting to approach historic norms in valuation. The market cap weighted index is moving closer to fair value but still has work to do.
What’s Priced In and What Isn’t
The above is of course the good news and a glass half full mindset. Every balance sheet has both Assets and Liabilities. We’ve looked at the silver lining but it’s important to delve deep into the dark clouds that still lurk out there.
(Click on chart to expand)
Bloomberg Data
We all saw the horrific inflation prints last week. The CPI and PPI both came in hot leaving little doubt the FED has a lot of work to do. The FED will do what it must to slow demand with the few tools it has. Markets have priced in a 3% Fed Funds Rate and the continued roll off of the balance sheet. What isn’t priced in is the potential that they are so behind the curve they will have to push rates significantly higher than 3%. Like it or not when rates go up multiples go down and with-it stock prices.
National Security Imperative
The added inflation challenge is that while the Fed can influence demand, it can’t do anything about supply. No question the supply chain issues being echoed in nearly every conference call have been a contributing factor to rising prices. Reshoring our supply chains isn’t just good business, it’s a national security imperative.
Even if inflation is peaking as many suggest, getting it down to 2% the Fed’s target isn’t going to happen anytime soon. At best it’s going to take a few years which means tighter financial conditions in an economy that is starting to slow.
STOP SCREWING UP
The only goal of the FOMC and Federal Government should be to STOP SCREWING UP. The continued crisis monetary policy well beyond what was needed and the administration flooding the system further with fiscal stimulus added fuel to an inflation fire that was already raging.
The inept energy policy that has forced America to pivot to OPEC while placing blame on energy producers for not stepping up is nothing but a blame game tactic. Energy companies aren’t going to explore new fields when there isn’t a pipeline to transport the product especially when policy seems to shift with every administration. Congress doesn’t get a free pass here either. An enduring energy policy needs to come from legislation not just by executive order.
The Consumer (Click on chart to expand)
Bloomberg Data
Much has been said about the U.S. consumer and their resilience in the face of every crisis. Apart from a COVID induced slowdown consumer credit has been relatively stable but recently there are signs that consumers are taping their cards driving credit levels higher. If charge offs rise credit card companies will be forced to cut credit lines slowing economic output further.
Goldman Lowers Target
All in we have a lot on hour plate as we step into week 20. Late Friday, Goldman’s David Kostin released a report raising estimates for the S&P 500 modestly while at the same time lowering his year-end target down to 4300.
The Fed Put
For most of the last decade investors have had the back stop of an implied FED Put knowing the FED would step in with added liquidity if markets experienced too much pain. Given the challenges we face I suspect if there is a FED Put it’s at lower prices and deep out of the money.
*At the time of this article some funds managed by David were long MSFT, GOOGL and XLE
