The Weekend Edition # 15

Welcome to another issue of the Weekend Edition. 

Thank you to all who’ve read and subscribed to the newsletter this week! The newsletter is gaining momentum and I’m so grateful.

Now, let’s grab a cup of coffee ☕️, while we take a look at what happened in the markets this week. 

Here’s what we cover:

• Market Recap - All time highs, spooky week and sticky inflation

• Halloween Special - An Inverted Yield Curve? 💀

• Earnings of Week - Amazon, Apple, Boeing, Hilton, Starbucks, Caterpillar, Mcdonald’s, Ford, Exxon, Facebook

• Around the Markets - The 1.75T Bill and some stocks to go with it; Meta

• The Week Ahead - FOMC Meeting; Jobs Friday; More Earnings

• Closing Thoughts

Let’s dive in ⬇️

Market Recap - Oct 25 - Oct 29, 2020

Apple got dethroned by Microsoft, Tesla broke $1T, and Facebook ain’t Facebook anymore. Spooky stuff… 

But overall a good week for the markets with the S&P closing at yet another all time high. According to FactSet, 56% of companies have reported thus far and of these 82% have reported above estimates. We saw a few more misses this week though, with Amazon being the one in the spotlight, followed by Apple. The Vix has inched up over the course of the week, but indices are all still happy!

Crude Oil & Natural Gas still remains at elevated levels and consumers are suffering. It will remain to be see what the next OPEC+ meeting brings. But, at this stage all signs point towards Crude heading to $100/bbl.

Housing data was mixed again with New Home sales increasing but Pending Home Sales decreasing. GDP numbers came in at 2% this week, much lower than the previous period’s 6.7% and the expected 2.4%. Concerns of stagflation (slow economic growth, high inflation), may not be unfounded.

What did the Personal Consumption Expenditure data tell us? Well Personal Income declined 1%, showing the impact of the decrease in social benefits. Expenditure increased but combined with a decrease in personal saving, shows people have now started to dip into savings. Inflation continues as the PCE and core-PCE both increased - PCE +4.4% YoY and core-PCE +3.6% YoY.

Inflation is sticky as my favorite expert, Samantha LaDuc, likes to say. And this is prompting the market to price in rate hikes sooner than expected.

Halloween Special - An Inverted Yield Curve? 💀

I was watching the rates screen on Bloomberg TV on Thursday and of course, the fact that shorter term yields are rising while longer term yields are not… sent off alarm bells in my head. “Could we see an inverted yield curve next year? And what happens if we do??”

And because it’s Halloween… let me tell you a scary story! 👻

What is an Inverted Yield Curve?

The Yield, as we know, is the return we get for investing in bonds, and we also know that the yield is inversely related to the price of bonds. So if bond prices go up, yields go down and vice versa. The Yield Curve is represents yields of different maturities plotted in nice tidy graph.

A normal yield curve is supposed to be upward sloping, with shorter term yields lower than longer term yields. It makes sense that you pay me more for investing my money for a longer period of time, right.

Why does the Yield Curve become Inverted?

While the shorter end of the curve is usually controlled more by Fed Policy, the longer end is driven by market sentiment.

More bond buying = Higher Prices = Lower Yields. So if people move money into bonds from stocks, or if international investors think the rates are better than their local rates (think negative yields in Europe), prices will go up, and yields will come down.

Thoughts of longer term inflation drive yields up, as people want more return on their investment to combat the erosion of wealth due to inflation. So if people don’t see inflation as a long term threat, bond yields at the longer end won’t factor as much of a premium.

So sometimes, short term rates start to rise faster than long term rates, so the yield curve becomes inverted or downward sloping. This could potentially happen.

Here are some theoretical yield curve charts and the actual inversion that happened in 2019.

Why could we see a an Inverted Yield Curve?

• As I said, we’re already seeing higher rates at the short end of the curve, versus the long end. On Thursday, the 20Y yield exceeded the 30Y yield for the first time.

• If inflation persists, Fed hikes could be sooner and more aggressive than we think. People are pricing in a rate hike, as early as July, right after the Tapering ends.

• Add to that, experts are now expecting more than one hike next year. Goldman Sachs came out with a report to clients on Friday saying that it’s possible that inflation will force the Fed to raise twice next year and, twice a year every year after that.

• Globally, Canada, Australia and Europe are announcing pretty aggressive rate hikes and this is influencing rate hike sentiment in the US.

This is where we stand now and you can see the Yield curve in bright red moving down towards the longer end. If this remains and we get rate hikes that move the shorter end fast enough, we may just have an inverted problem on our hands.

What happens if we get an Inverted Yield Curve?

A persistent inverted yield curve has been a good predictor of a coming recession. According to this Forbes article: “Over the past three recessions, when the result turns negative the economy has entered a recession 8 to 13 months later all three times since 1990.”

What does it means for stocks? You’d think with lower longer term rates, life would be good. But, not really. Stocks get hit in anticipation of a recession and there is some correction.

Scary enough?

I didn’t mean to spook you too much! But an inverted yield is quite possible, if the Fed’s policies don’t strike a balance with the market. But, all’s not lost. A temporary inversion it the yield usually means nothing. It’s happened on many occasions and reverted to normal. But, if it’s allowed to continue, that’s when we should worry. As of now, market experts are not too worried though.

But there’s one important thing to consider… the eternal optimist in me says, you can always find great companies to invest in. That’s the best part about the stock market, somewhere someone will deliver.

Earnings of the Week

This week, I’m changing up the categories a little bit. We know that supply chain issues are hitting most companies and so is inflation. So, I’m combining supply side and cost pressures, demand & market sentiment, ESG, and adding External Factors. Let’s go…

Supply-side, Inflation and Margins

• Amazon (AMZN) saw inflation costs of $2B, with $1B coming specifically from wage inflation. They project these costs to increase to $4B in the 4th quarter. They’ve increased wages to $18/hr with sign-on bonuses of up to $3600. Labor was the biggest driver of cost and not, supply chain disruptions. They actually had to redirect shipments to other warehouses because of labor shortages.

• McDonald’s (MCD) posted superb earnings despite all the cost pressures. But, they did mention that they think the staffing problem is not solvable and will remain for several quarters. As we saw with Domino’s and Chipotle in the previous weeks, operating hours and delivery is impacted by labor shortages, despite higher wages. They also say that they didn’t see resistance to pricing increases!! McD’s remains a staple.

• iPhone revenue jumped 47% yr/yr to $38.9B yet, Apple (AAPL) posted a quarter short of expectations. But, was it really short? They warned us, didn’t they? (I’m biased!)

• MasterCard was one to say that they will actually benefit from moderate inflation because their pricing is a percentage of transaction costs so, higher prices = more money for MA.

Demand & Spending

• Amazon says that pre-pandemic spending patterns have returned with people spending on travel and services. But, much of the spending through Amazon remains sticky and they’ve added enough physical capacity to get through the holiday season. Labor is the main challenge that they still see.

• Caterpillar (CAT) delivered a decent quarter on the back of residential construction growth but cited that the non-residential construction (infrastructure) still remains below pre-pandemic levels. (That’s about to change!)

• Caterpillar’s Power Generation segment remains strong, growing 22% because of increased demand for power at data centers!

• Hilton (HLT) saw a 98.7% increase in RevPAR (Revenue Per Available Room) compared to 2020, a good sign of recovery. Compared to 2019, however, RevPAR is still down about 19%.

ESG

• Airlines have retired or announced plans to retire around 1500 airplanes since the onset of the pandemic and are moving to reduce carbon emissions. David Calhoun says Boeing’s new planes will be “25%-40% more fuel efficient with commensurate reductions in emissions”. (BA)

• Ford (F) announced a move towards enough battery production to meet their 2025 goal of 141 gigawatts, which is enough to build more than 1 million battery electric vehicles a year. Jim Farley’s certainly giving it his all!

External Factors

• So last week we heard from Snap on how Apple’s iOS 14+ changes are affecting their revenues. Well, Facebook (FB) had the same issue this time around. Their accuracy of ad targeting decreased leading to higher costs and “measuring those outcomes became more difficult”, leading to underreporting of their value-add.

• Starbucks (SBUX) saw 20% decrease in revenues in China due to Delta Variant store closures but, McDonald’s surprising fared ok.

• I can’t help but mention - Exxon Mobil (XOM) generated cash flow of $31.6B year to date. What a massive turnaround! To think, a year ago they were struggling to keep their dividend in place.

Around the Markets

The $1.75T Budget Reconciliation Bill

Here’s a brief summary of spending items in the bill:

• Increased spending on Education and Child Care; up to $3600/year tax cuts per child

• Increased investment in care for the elderly and people with disabilities

• Rebates and tax cuts for moving to clean energy, electrification and increasing usage efficiency

• Investment in  clean energy technology - from wind turbine blades to solar panels to electric cars (Stocks to Watch: TSLA, GM, F, FSLR, TAN, ENPH)

• Invest in Medicare and strengthen the Affordable Care Act (Stocks to Watch: UNH, CNC, UHS, ANTM, HUM, MRK, LLY, XLV)

Ladies and Gentlemen… enter the Meta…verse!

Sorry, I couldn’t help myself! No newsletter for this week would be complete without this!! The ticker symbol is supposed to change on Dec 1, 2021 to $MVRS. I did like that they’ve decided to split their reporting into two - FB Apps and FB Reality Labs. It gives investors a chance to see what’s being invested and the results.

The Week Ahead

Economic Calendar

FOMC Meeting on Nov 2-3, 2021 - Statement on Wed Nov 3, 2021 2pm ET

It’s finally here… the Fed meeting that we’ve been waiting for! I don’t know anyone who thinks the Tapering Announcement will not be made. It will be a major shock, if it isn’t. Fed Chair Powell has been leading up to this event, with his… we will give you enough of a heads up. Well, we had Jackson Hole, the last FOMC meeting and his recent very firm statements at the BIS Panel Discussion. Buckle up!!

ISM Manufacturing Index - Mon, Nov 1, 2021

Jobs Data - Friday Nov 5, 2021

Earnings

Life’s never boring when it’s earnings season… some excitement for next week. ⬇️

Closing Thoughts

If the Fed does announce the taper next week, the markets are sure to react, even though we’re seeing it coming. I still think we see a run up in the S&P until the end of the year but, it will be wise to keep your guard up.

How the tapering progresses will determine the timing and pace of rate hikes, and the residual impact on the Global Economy… something I’d like to cover in the days to come. So stay tuned!

On a personal note, this week I joined the Commonstock Creator Program! It’s a fantastic website for all things stock related. I’ve been looking for a space between the short-form Twitter and the long-form Substack and I’ve found my HG. Commonstock has a fantastic feature of memos, and I’ll be taking full advantage of it throughout the week. Come join me and a whole host smart creators talking stocks!

Here’s wishing you a happy weekend and safe investing… & Happy Halloween!! 🎃

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers

None of the above is Investment Advice. I may or may not have positions in any of the stocks mentioned. I have a long position in $AAPL, $FB, $CAT, $BA, $F, $MSFT, as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.