State of the markets - Dec 27th 2022
Markets: What I am watching and doing in the markets this week
First off, as we cross over into a new year later this week, I would like to thank you for being a solid supporter of my work for the past 12 months. It has been a fun ride and I have enjoyed every minute of it. Your readership and patronage means a lot to me. Thank you!
Last week I posed the question below as food for thought:
Can the US Fed steer the economy towards a soft landing?
There are many opinions on this matter. Here is what I think.
The US Feds need to precisely balance three economic factors to land a soft landing - inflation, labor and growth. I am 100% sure that they will not be able to control all three to the extent that they desire, however, I believe that a softish landing is possible.
Inflation - is steadily coming down. We have already seen five months of such lower trending data in the US (June was the peak) and this slide is expected to continue. Sales are coming down. Consumer sentiment is depressed. Commodity prices are tanking. The Feds state that their goal is to bring inflation down to 2%. I think a 3 to 3.5% inflation target makes more sense…a little bit of inflation is actually good for economy. Just ask the Japanese.
Unemployment - will rise as consumer demand comes down. Businesses will sell less stuff and they will, in turn, look to cut costs. Labor is almost always the largest expense line item on the income statement and management’s first target for cuts. They will defer hiring plans and reduce existing headcount via attrition and layoffs. I do not believe that the US needs to see more than 5% unemployment in order to beat inflation and prevent a recession. The US economy is very different and more resilient today versus 2008-2009, when we experienced the previous recession. Businesses are more automated. Workers can work remotely. E-commerce is ubiquitous. The financial sector is well capitalized. The gig economy has redefined the meaning of a job. Sure, there will be some labor related pain in 2023, however I do not expect it to be deep recession level stuff. And we have to remember that the labor force in the US has shrunk post-pandemic…so there are actually less workers to hire, to fire and to raise the unemployment rate.
Growth - In 2023, we can expect to see the US economy put in a couple of quarters of negative or close to 0% GDP growth. There is no way to avoid this. Q3 2022 GDP growth came in at 3.2% (see below). Q4 will likely be in the 2% range further contributing to the downward trend. However, today, the US economy is the strongest in the world (please drop a comment if you disagree). Europe is on the backfoot. China is dealing with COVID. India is doing well and will likely enjoy symbiotic strength with the US next year. So I believe that our economy will rise from the 2023 depths rather quickly.
So what could derail a soft landing possibility? A black swan event or two could do the trick - military actions in Taiwan, COVID-related chaos in China or something else that we cannot foresee right now.
In my next post on 2023 repositioning, we will dive deeper into this topic and you will see how the data supports my soft-landing hypothesis.
It was a relatively quiet week for the SP500 last week - low volume, low liquidity and almost no change in the value of the index.
The Fear & Greed index stayed in the Fear sector all week as investors got increasingly nervous that the expected Santa rally did not show up last week.
However, the options markets started getting more bullish for equities and vice-versa for bonds. This was a 180 degree change from the previous week.
But then, we also received an update from the American Association of Individual Investors (AAII) that bullish sentiment fell to 20.3% from 24.3% the previous week, while those who said they were neutral on the outlook for stocks dropped to 27.4% from 31.1%. The bears in this survey tagged 52.3%, a nine-week high.
Lots of conflicting signs around.
US $DXY - Has not moved much over the past week. It remains on a downtrend.
Oil - Has been slowly climbing about 8.5% since early Dec on suspected future, OPEC production cuts. The US Dept. of Energy said it will begin buying back oil for it’s Strategic Reserve, starting with a small 3M barrel purchase in Feb.
Natural gas - continued to fall as much as 25% over the past week due to reduced demand in Europe and ample inventories on hand. Even Russia has started repairing it’s damaged gas supply pipe (to Europe) and has indicated that it is willing to restart supplies as soon as possible.
A few key learnings from last week floated to the top of my notes:
We are now entering the pre-earnings (Q4) stock buyback blackout period. By the first week of Jan 2023, almost all SP 500 stocks will not be able to repurchase any of their shares until they report their quarterly earnings.
Goldman Sachs expects buybacks to decline by at least 10% in 2023 due to an economic slowdown. In past recessions, share buybacks have reduced by as much as 46%.
Q3 2022 GDP was finally revised to 3.2% growth, higher than the previously reported 2.9%. The US economy was stronger than we knew in the third quarter.
The Core PCE (Personal consumption expenditures) is the US Fed’s preferred inflation metric and last week, it reported a 4.7% yoy increase in Nov versus 4.6% expected and the 5% Oct number. Month over month, it gained 0.2% which was in line with expectations and slower than Oct’s 0.3% increase.
The full PCE was 5.5% for Nov versus 5.5% estimated and lower than Oct’s 6.1%.
Homebuilder sentiment dropped to 31 in Dec, marking the 12th consecutive monthly decline in the index and one of the lowest readings since 2012 (except during the pandemic).
Housing permits are down. Housing starts (new home construction) are down. Home sales are down. Seller inventory is down. Buyer interest is down. The median sales price for existing homes crept up 3.5% yoy, having increased for 129 months straight.
Net farm income in the US has increased to $160.5B in 2022, its highest level since 1973. This is due to rising prices from crops and animal products. Farmers will see about a 14%yoy increase in income and the value of their land has also increased about 14%yoy to a record $5,050 per acre.
The US is dealing with one of the worst bird flu outbreaks in recent history. Tens of millions of chickens and turkeys had to be put down to contain the spread of the disease. This is something to keep an eye on.
FDX - lower earnings beat expectations but provided gloomier 2023 forward guidance; will cut $1B in costs
MU - reported a drop in sales and net loss for Q3 along with a weak forward guide; layoffs announced
NKE - beat on earnings; with expanding margins along with rising inventories; raised forward guidance
Jobless claims for the week of Dec 17th were 216,000, including an increase of 2,000. This number continues to stay at historical lows and is not enough to convince the US Feds that a pivot in rate hikes is near.
Layoffs - Micron announced it would reduce its headcount by about 10% in 2023.
Sam Bankman-Fried (SBF) was extradited to the US, from the Bahamas. He appeared in US court and was released on a $250M bail. I wonder where this bail money came from?
Binance US has agreed to buy Voyager Digital assets in a deal worth $1.022B. Perhaps Voyager customers will be able to retreive some or all of their tied-up assets.
Consumer confidence in Europe rose for the third straight month as energy prices continue to drop and inflation showed signs of easing.
US consumers showed similar positive expectations of inflation falling over the next 12 months and the next 5 years, according to the University of Michigan survey. Even the Conference Board Consumer Confidence index was higher at 108.3 vs. 101.4 expected.
COVID-19 cases continue to rise in China. The govt. has stopped reporting its daily case numbers and death tally. This is going to be a tough and deadly winter in China and the effects will be felt all over the world.
Chinese policy makers announced that economic growth will be a priority in 2023. The Chinese govt. is expected to announced large fiscal and monetary stimulus to jump start it’s economy after months of lockdowns. Chinese households’ bank balances are up 42% since 2020, amounting to about $4.8T. Domestic and international companies are hoping this could lead to a surge of consumer spending.
You have probably heard of Quantitative Easing (QE), which the US Feds adopted as a strategy for most of the last decade, leading to one of the strongest bull markets in the US. Well, the Bank of Japan (BOJ) invented QE and a few years ago, they upped their game by adopting yield-curve-control (YCC). In YCC, the Japanese central bank is carefully buying just enough Japanese bonds to maintain short term rates at or around 0% and long term, 10-year interest rates at or around 0.25%.
In a surprising move, last week, the BOJ announced that they would expand their YCC target from 0-0.25% to 0-0.50%. Over the past 12 months, while central banks all around the world have been raising rates to curb inflation, the BOJ had stuck to their YCC 0-0.25% target. This new YCC expansion signals a possible rate hike in 2023, leading to a rise in the yen (coupled with a drop in the US$ DXY)
The European Central Bank (ECB) expects inflation to peak this quarter with a 4.2% core inflation estimate for Dec 2022. European core inflation has lagged US core inflation by 6 months. So they have more rate hike pain ahead.
UK’s Q3 GDP was 1.9%yoy, lower than the 2.4% estimate and the previous quarter’s 4.4%.
Key market events
It will be a relatively quiet week and we will gladly take it!
Tue Dec 27 - Home price index
Wed Dec 28 - Pending home sales index
Thu Dec 29 - Jobless claims
Mon Jan 2 - Markets closed
I continue to believe that there is more upside risk in the market. I am not giving up on the Santa rally just yet
Markets and trading will again remain largely muted this week on relatively low volume. Low volume can produce high volatility to the upside or the downside, solely depending on news and events
Here is what I plan to do with my portfolio…
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