The Weekend Edition # 19

Welcome to another issue of the Weekend Edition. 

Thank you to all who’ve read and subscribed to the newsletter this week!

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 - Black Friday turned Red

• Macro - the Markets Next Week

• Earnings - What we’ve learned so far and a few reviews

• The Week Ahead - Event Calendar

• Closing Thoughts - let’s stay sharp

Let’s dive in ⬇️

Market Recap - Nov 22 - Nov 26, 2021

This week saw declines across the board first in tech and then in cyclicals, with news of a new Covid variant. The big news of the week was J. Powell getting re-nominated as Fed Chair and, Lael Brainard being nominated as Vice Chair. Both are said to have a dovish stance so, while the market expects higher rates sooner, we’ll just have to wait and see.

I’d posted these two snapshots on Twitter earlier in the week. I thought it was worth looking at them again because it captures a good summary of what we saw in the markets. Earlier in the week, Tech was selling off and money was moving steadily into the cyclicals. Unfortunately, with the news of the new Covid variant, we had a turnaround with heavy selling in Energy and Financials.

Just as we thought things were getting better, Black Friday saw a steep decline:

• The Dow declined over 900 points - with American Express (AXP) and Boeing (BA) leading the decline. This was the largest one day decline since May. But, the weekly decline was offset by the shift to cyclicals earlier in the week.

• The Russell 2000 however, got hit hard over the course of the week, declining over 4%.

• The Vix shot up, gaining almost 60%, most of it Friday, the 4th largest increase in history. I doubt we see a steep decline in the Vix next week either, with more news of the Covid variant spreading.

• Bonds were seen as a flight to safety and prices rallied on Friday. Bond yields saw sharp declines with the 10-year falling below it’s 50-day moving average, putting pressure on the Financials.

Oil

The sharpest decline in commodities came in oil prices as both WTI & Brent declined over 10% on the news of restricted travel, further expected lockdowns and the imminent release of oil from the Strategic Petroleum Reserves (SPR) across the US, Japan, India and China.

The release from SPRs now seems premature and it would seem that the decision taken by OPEC+ not to increase production is justified.

According to experts:

• The decrease in jet fuel due to flight cancellations is likely to be 20,000 barrels per day. This isn’t a massive change and will like remain so unless transatlantic or global flights are stopped.

• In two weeks, we should know if the vaccine is effective. This will likely see oil go back to $80/bbl.

• OPEC+ is unlikely to make drastic changes to production capacity of 400,000 barrels per day, given that they still see global demand to be weak and with the newest lockdowns across Europe, demand will continue to falter.

Macro - The Markets next Week

A few weeks ago, I did a podcast and I was asked the question - What happens if we have another Black Swan event? My answer to that was, we’re already living through a black swan even so to speak, and nothing can probably surprise the market anymore. I need to eat my words because it seems like there’s still some room for surprise.

New Variant Spread - One possible reason

The new variant, Omicron, is said to come from Southern Africa. I know from experience that the DeBeers Sightholder Diamond auctions take place 10 times a year in Southern Africa, namely Botswana, Namibia and South Africa. People travel from various parts of the world for this. This is one reason that the variant could be carried back to other diamond hubs and possibly a reason that Belgium is already seeing cases.

Rates

The drop in longer-term rates now signals a lower probability of a rate hike. Earlier this week FOMC members started talking about increasing the pace of tapering, given the persistence of elevated inflation. But, given what we saw last week, the rate hike proponents have backed off a bit. We may see some pressure until the covid news eases.

Sectors

Volatility will remain elevated, as we see sectors such as Hospitality & Travel decline further. The flight to work from home stocks - Zoom, Netflix - is likely to continue but, probably not for long. If you look at the sectors chart for Friday (above), the three sectors that sold off the most were Industrial, Financial and Energy. I expect this will continue to an extent as long as we don’t have any reassuring news on the new variant.

Silver Lining

Pfizer announced that they would need 2 weeks to test the efficacy of their vaccine against the new strain and if required, they could modify it within 6 weeks and start shipping within 100 days. While that’s good news, the time lag isn’t exactly comforting. That could mean one more quarters of lockdowns and disruptions in activity. 

However, this time countries are responding faster. Before the WHO could even declare it a concern, most countries have already stopped flights from Southern Africa. Nevertheless, until the market sees where the response is headed, we're likely to see more selling pressure. Market breadth started to weaken the previous week as I wrote in my newsletter and the wait & watch approach would be prudent.

My favorite optimist

Tom Lee, ever the optimist, spoke earlier in the week saying that he still sees S&P crossing 4800, oil at +$100/bbl and Bitcoin to $100K. This was however, before Black Friday and I’m eager to hear what he has to say with the new Covid threat.

Earnings of the Week

What have we learned? - Stocks resilient to inflation

As earnings season started this time, I decided to examine them through a macro lens, looking at how companies were affected by inflation, supply chain disruptions and labor shortages leading to rising wages. So what did we learn? We learned that companies doing well in these circumstances are:

• Companies where margins can take the beating - Apple, The Trade Desk

• Companies where prices can be increased and people will still buy - Chipotle, Domino’s

• Companies who have the power to control their supply chain - Walmart, Costco

• Companies with cost structures that benefit from inflation - Companies that own their own real estate like Macy’s; others such as Banks and Financials

• Companies that have inflation built into contracts - REITs like WPC, FRT

• Companies causing inflation - Energy companies - CVX, XOM

I think we’ve pretty much covered our Macro take on earnings. So for this week and what’s left of the season, we look at highlights from a few names.

Deere (DE)

Deere solved their employee issues just in time to release a great set of earnings. Despite supply chain challenges, the semiconductor shortages, and 10,000 workers going on strike, the company posted stellar top and bottom line results. Total net revenue for the company was actually USD 11.3B for the quarter.

Precision Agriculture sales grew 23% year on year and the company guided that they are poised for further growth, net year. Given the increase in commodity prices, farmer’s are faring better and investing in new machinery and upgrades. There’s also no doubt that Deere’s construction equipment division will benefit from the recent infrastructure bill.

(I’m long Deere and clearly biased)

Gap (GPS)

Gap is feeling the full force of the supply chain nightmare. After several quarters of strong growth, Gap missed both earnings and revenue estimates. What’s more worrying is that the Company is guiding almost half of what it was expecting at an EPS of $1.2 - $1.4, vs. previous estimates of $2.10 - $2.25.

Gap has been particularly hit because of their heavy reliance on Vietnam, just as we saw with Nike’s last quarter. While demand still remains strong, the company’s lost almost $300million in sales because of the empty shelves.

Other earnings news:

• Dollar Tree will increase their pricing by 25% to $1.25 to cover rising freight costs.

• Zoom posted strong growth in revenue and earnings, yet the stock price dropped again on sentiment. This comes as no surprise after last quarter when a slowdown in users had the same effect.

• VMWare posted good results but investors are not seeing the pickup in pace for their SaaS offering, as they’d expected. Still, this will be one to watch as the company transforms its cloud offering from on-prem.

The Week Ahead

Economic Indicators

• Monday, Nov 29, 2021 - Pending home sales

• Wednesday, Dec 1, 2021 - ISM Manufacturing Data

• Thursday Dec 2, 2021 - OPEC+ meeting

• Friday, Dec 3, 2021 - Jobs Friday - November Payroll data

Earnings

Closing Thoughts

I could tell you not to panic; I could tell you this is just a knee-jerk reaction to the news. But instead, I’ll leave you with some wise words from Morgan Housel:

Over the next couple of days, the new Covid variant story will play out and we just have to watch how the market reacts. For long-term investors, it presents opportunities to “buy the dip”, but only once the market shows signs of a reversal. Otherwise, we won’t know how far down the dip goes. Let’s stay sharp!

Here’s wishing you a happy weekend and safe investing. 

Sincerely yours,

Ayesha Tariq, CFA

@ayeshatariq

There’s always a story behind the numbers

None of the above is Investment Advice and all views are personal. I may or may not have positions in any of the stocks mentioned. I have a long position in $DE as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.