Groundhog Day

By Crest Capital Advisors on April 22, 2022

Dow: (1.86%) to 33,811.40
S&P 500: (2.75%) to 4,271.78
Nasdaq: (3.83%) to 12,839.29
Russell 2000: (3.21%) to 1,940.66
10 Year Yield: 2.90%
Outperformers: REITs 1.31%, Consumer Staples 0.39%
Underperformers: Communication Services (7.74%), Energy (4.56%), Materials (3.72%)

US stocks were down again this week, with the S&P attempting to rally early in the week only to encounter significant weakness on Thursday and ending even further near the lows on Friday. This marks the 3rd straight weekly decline for the S&P and Nasdaq.
The week’s slide was broadly attributed once again to “hawkish” central-bank commentary by the Fed that provided the impetus for another bout of higher Treasury yields. But this is nothing new as the Fed has been talking tough about inflation for months and months now. Yet, here we are, seemingly re-living the same angst each time a Fed speaker addresses inflation and interest rates, as though we’re experiencing it again for the first time every time. This week’s culprit was the characterization of Powell “blessing” a 50 bp (0.5%) rate hike in May (supposedly already the consensus).
But on the flip side, Q1 earnings are thus far outpacing expectations. While earnings calls remain replete with references to cost pressures and supply chain challenges, demand commentary has been positive on the whole, with airlines, in particular, benefiting from the economic normalization theme. The vast majority of companies are having no problems passing price increases through to end customers.
On the geo-political front, the market seems to be taking less notice of developments in Ukraine, despite Russia intensifying its activity in the east and south.
Looking ahead to next week, we move into the heart of earnings season so corporate headlines will be coming fast and furious.

Front Running the Fed

After the past few days, the number of rate hikes expected by the market in 2022 is now approaching 10, for a total of 250 basis points (2.5%) overall! The chart below shows the market-implied number of hikes, clearly, a relentless uptrend over the past 6 months and a significant headwind to stocks and bonds as traders continue to dial up the levels of expected monetary tightening. Every time we think the market has finally priced in enough tightening, the rhetoric from the next Fed speaker seems to dial up the pressure even further.
To be certain, the market has substantially front-run the Fed (which has only officially moved rates one time thus far) and financial conditions have tightened materially beyond the current level of the Fed funds rate. Could this market-implied pricing negate the need to actually tighten policy to levels the market expects? Time will tell but we have more thoughts on this concept below.

Unpopular Opinions

Contractionary fiscal policy is already slowing nominal income growth down to just 4% right now, with nominal GDP likely moving down to a similar pace. Alongside higher interest rates, decelerating money supply (M2) growth, and the popping “stay at home” bubble for goods (e.g. Pelotons, computers, etc), we expect inflation is set to slow sharply this year. As a result, the Fed will not be as aggressive as the market now fears. Clearly, this is a very unpopular opinion to hold today, especially when the day-to-day market price action would seem to indicate this conclusion is not at all correct.
But, let’s break it down further and look at the details …
First, we note the 2021 fiscal spending surge obviously contributed to that year’s nominal GDP surge via stronger disposable personal income (DPI), and in turn, stronger consumer spending. The consumer balance sheet in 2021 was stellar, perhaps as good as it has ever been. But, what we believe investors may be overlooking is the substantial 2022 spending contraction (no more transfer payments or checks to stay home and not work) will have the exact opposite effect.

With fiscal stimulus now gone, Disposable Personal Income (DPI) is back to its pre-Covid trend growth of ~4%. And given DPI’s 85% correlation with nominal GDP, topline economic growth should retreat to 4% as well.

This lower level of activity is showing up in the ISM New Orders and Leading Indices. The chart below shows the 6-months ahead forecast for new orders from the ISM survey and the Leading Index. You’ll note that both data sets are rolling over and likely to continue lower over the coming months. CEOs are telling us to watch out for a growth scare.

Overall, we expect substantially lower real GDP growth and the ISM models are pointing to slower activity as well. With federal outlays falling and money supply contracting, all of this together suggests inflation will slow sharply, and the Fed won’t need to take funds anywhere near the levels being discounted today. If this proves to be accurate, then we’d expect a substantial rebound rally for markets across the board.

Contrarian Corner

Speaking of contrarian points of view, we present the following as food for thought. As markets once again are reaching extreme levels, the odds of a healthy reversal in a positive direction are growing.

First, we present the sentiment data which shows that Bullish sentiment has plunged to the lowest level since 1992! This is clear anecdotally as well as we have a hard time finding any strategists willing to step out on a limb with a bullish thesis.

At the same time, bonds have also been under significant pressure in 2022 as well. In fact, according to data from our friends at Strategas Research Partners, the 20-year Treasury ETF is the furthest away from its 200-day moving average in history! (Note: Trading at wide spreads above the average of the last 200 days is a sign of extreme sentiment change)

Elon Buys Into Twitter…Part 3 – “Funding Secured”

As we have been writing over the last two weeks, we have been highly entertained by the corporate drama around Elon Musk’s attempt to take Twitter private. This week brought its share of new developments.
When we left you last Friday, Twitter’s Board was assessing Musk’s offer and market rumors were suggesting that Twitter was trying to find another buyer – the sense being that the Board that had previously welcomed Musk’s involvement when Musk was joining the Board, was now vociferously against Musk taking control for a premium stock price. It was rumored on Sunday evening and then announced Monday morning in an 8-K filing with the SEC, that the Twitter Board of Directors had adopted a “poison pill” strategy. For CMD readers that were not around during the 1980s when this strategy was developed, a poison pill strategy involves allowing all current shareholders (except for Musk) to buy more shares at a discounted price. The filing also confirms that the strategy will kick in if an “Acquiring Person” (like Musk) buys 15% or more of Twitter’s stock. What this effectively does is almost double the shares outstanding, thereby making it harder for Musk to get the votes needed to support a deal, ultimately diluting existing shareholders but also making a buy substantially more expensive for Musk.
On Thursday morning, Musk filed an amended 13D with the SEC confirming that he has “funding secured”(fans of Tesla will understand the quotation) for buying Twitter. The filing states that the total amount secured via various kinds of loans and equity financing is $46.5 billion. The filing also mentions that Musk is considering starting what’s known as a “tender offer.” That’s when current shareholders are invited to sell their stock to an investor at a particular price. In this case, Musk is considering a tender offer in which he would buy shareholders’ stock at $54.20 per share. But it is important to remember, as Musk reminds everyone in this filing, that though he has secured funding and is considering a tender offer, that doesn’t necessarily mean a takeover will happen. Just that it is possible. And the filing also makes it clear that it is just as likely that it may not happen either, that Musk still “reserves the right to withdraw the proposal or modify its terms at any time including with respect to the amount or form of consideration.”
Later on Thursday, there were headlines that Musk is in talks with private-equity firm Thoma Bravo about partnering on a possible takeover bid for Twitter which could potentially increase the price and/or capital behind the offer.
We are eagerly awaiting what will come next……

Netflix and Chill Crash

This week, the highest-profile earnings beat-down was administered by the market when Netflix surprised the market and announced a contraction in the number of users for the first time in more than a decade. As a result, the stock closed down a whopping -35.12% on Wednesday and as of the close of trading on Friday is down -64.23% year to date.
Netflix has grown its revenues by 138% over the last 4-years, and the stock is down 33% over that time. How did that happen? It was trading at over 11x sales 4-years ago v. 3.3x sales today. Lesson: When growth slows, valuation suddenly seems to matter.

Crazy Stat(s) of the Week

Here are this week’s crazy stats:

• Corporate profits have been so strong that corporate taxes are generating more revenue for the government at a 21% tax rate than at a 35% tax rate! The chart below shows the actual taxes raised (red line) v. the pre-tax cut level (blue line) rate and the forecasted post-tax cut (green line) rate.

• US Companies Have Repatriated $1.8 Trillion Of Overseas Seas Profits Since The 2017 Tax Cut. The 2017 Tax Cuts and Jobs Act not only lowered the corporate tax rate but also broadened the tax base by creating the first round of taxes on overseas profits and imposing a mandatory tax on unremitted foreign earnings that have accumulated over time. Since companies are now forced to pay a tax on their overseas earnings, the cash is coming home with $1.8 trillion of cash repatriated in the four years since the tax cut was enacted. The four-year average was about 2.1% of GDP, up from the previous average of 1% of GDP pre-tax cut. The availability of these earnings is likely helping companies cushion the blows inflicted by COVID and inflation.

Quote of the Week

“There will be bear markets about twice every 10 years and recessions about twice every 10 or 12 years, but nobody has been able to predict them reliably. So, the best thing to do is to buy when shares are thoroughly depressed and that means when other people are selling.”
-Sir John Templeton

Calendar of Events to Watch for the Week of April 25th

With only ~20% of the S&P 500 reporting Q1 earnings so far, earnings activity will remain front and center on the calendar for the next few weeks. Notable reporters next week include the Big 5 (Google, Amazon, Apple, Microsoft, and Facebook) as well as a host of other influential large-cap names. On the US economic calendar, we get readouts on Durable Goods Orders, Housing, GDP, and wrap the week on Friday with Inflation data via the Personal Consumption Expenditure (PCE) report. It will be a busy week with plenty of headlines to move markets in one direction or the other.
Monday 4/25 – The Dallas Fed Index report for March is expected to post an 11.3 reading, up from 8.7 in the prior period.
Tuesday 4/26 – US Durable Goods for March is expected to come in at 1.2% month-over-month, an improvement from the -2.1% contraction in February. We’ll also get the Case-Shiller home index for February (expected to show a 19.2% year-over-year increase) as well as March New Home Sales.
Wednesday 4/27 – US Pending Home Sales for March are expected to contract -1.7% due to higher mortgage rates constraining housing market activity.
Thursday 4/28 – The First Preliminary reading for Q1 GDP is expected to show a 4.2% year-over-year headline rate, down from Q4’s 5.5% rate.
Friday 4/29 – The Fed’s favored measure of inflation, the Personal Consumption Expenditure (PCE) report is expected to show a 0.9% month-over-month rate and 5.3% year-over-year. Any moderation in this data set would be a welcome relief to investors as it could alleviate the pressure on the Fed to act aggressively.

Source: FactSet