The Weekend Edition # 28

Welcome to another issue of the Weekend Edition. 

Thank you to all who’ve read and subscribed to the newsletter this week! We’ve now crossed 2000 readers and I am so very grateful.

Here’s what we cover this week:

• Market Recap - Bear Rally?

• Macro of the Week - The Fed, Rate Hikes, & Yield Curve

• Earnings of Week - Apple, Microsoft, Boeing, McDonald’s, Caterpillar, MasterCard

• Around the Markets - Changes to the S&P Index, Shipping

• The Week Ahead

• Closing Thoughts

Let’s dive in ⬇️

Market Recap - Jan 24 - Jan 28, 2022

We certainly had a choppy week, finishing almost flat over the course of the week after all the broad market indices had a nice bounce on Friday. Here’s the closing ⤵️

We had a few major earnings during the week and while Tesla gapped down significantly on earnings on Thursday, it made a bit of a comeback on Friday. Not to mention, Apple and Microsoft both delivered earnings that were fantastic and the bump in the stock price certainly may have helped the market.

While the green close to the week is encouraging, I don’t know if we can call this is a market bottom. But, what I do know is that the Russell 2000 is deep in correction territory, borderline bear market. The Nasdaq isn’t far from the -20% bear market cut off and the S&P is still chopping around with weak market breadth. This could be a bear rally but, maybe not a reversal. We’ll need to watch closely if the rally turns into an uptrend.

And in other news with political tensions heating up around the globe, and supply shortages still prevailing, oil is making new highs. Oil stocks are topping the charts. Brent hit $90/bbl and WTI coming close before closing at $86.62/bbl.

Macro of the Week - The Fed, Rate Hikes & Yield Curve

The FOMC meeting and announcement was this week and no surprise the Fed left the rates unchanged. By now, I’m sure everyone’s picked up on the fact that while the press release sounded very dovish, the Q&A during the press conference was anything but.

As the Fed turns more hawkish, with a discussion of looking at balance sheet management and a possible decrease in assets outright, the market is showing signs of panic. The market is now pricing in a full 100bps (1%) rate hike by September 2022 and worse still there are those calling for either a 50bps rate hike in March or 7 hikes (BoFA). 

How’s the market reacting? Not well, obviously. The Fed is adamant that they will do what is necessary to curb inflation and for good reason. According to the Fed, households, businesses and banks are in good shape and a tightening of financial conditions is warranted. How tight is the question now?

Powell overcorrected in 2018-2019 and had to walk back his decision. How likely is he to make the same mistake again?

As for yields, we’re seeing a definite flattening of the yield curve already and an inversion of the yield curve has now become a very real possibility. I had covered the “Inverted Yield” curve as a scary thought for my Halloween Edition last year, for the simple reason that nothing good ever happens when the curve inverts. For a full explanation of an Inverted Yield Curve, please read the section from that newsletter.

The Fed Chair acknowledged the possibility that this could happen with yields going up and longer term bonds becoming attractive to international investors looking for high grade sovereign debt.

Another interesting note that I came across since writing that article is that pension funds are also another factor in play. 

According to Merrill Lynch, pension demand could weigh on long-term yields even as the Federal Reserve tightens monetary policy. “Pensions funds, with total assets in excess of $3.5 trillion, could add $150 billion to $250 billion of fixed-income assets in the next 12 months, on course for the biggest flows since the global financial crisis. Their demand could ‘flatten the curve more than normal for a rate hike cycle’.”

Where do we stand now?

• 2-yr: -2 bps to 1.17% (+18 bps for the week) 

• 5-yr: -4 bps to 1.62% (+7 bps for the week) 

• 10-yr: -3 bps to 1.78% (+3 bps for the week) 

• 30-yr: -1 bp to 2.08% (+2 bps for the week)

Well, the yield curve has certainly flattened in the last few weeks. Aggressive rate hikes could certainly tip the scales as we saw back in 2019. The chart below shows the difference between the 10-year yield and the Fed Funds, which went into negative territory in 2019 signaling an inversion of the yield curve. ⤵️

Earnings of the Week

That’s one long list of earnings and it’s not even the full list. I haven’t managed to catch up on all the earnings this week. But, here’s a summary of a few that I did get to:

• Apple (AAPL)’s chart should probably tell you everything you want to know. Apple delivered a solid top and bottom line, well above expectations. I think most people were ready for Apple to disappoint given all the news around chip shortages and supply chain constraints. The only troublesome segment was iPad sales which dropped 14% YoY to $7.25B. iPhone revenue was up 9% to a record $71.6B and Mac up 25% YoY to $10.9B. To top it off, Apple now says they expect see better supply chain conditions during the March quarter.

• Microsoft (MSFT) delivered a strong quarter but perhaps not as outstanding as their previous quarters, which is why the stock initially dropped but later rebounded on strong guidance from the company. The Cloud business remains the fastest growing segment with Azure at +46% QoQ but, the surprise came in from the hardware business with OEM revenue jumping 25%, due to the holiday season. Looks like Surface and XBox still remain popular gifts during Christmas.

• Boeing (BA) had a tough quarter with a larger than expected loss in Q4, much of it because of a non-cash charge due to the delay in their 787 program. They’re also expecting Q1 to be challenging but likely sees 737 deliveries to China, which is a positive. Nevertheless, they did post positive FCF this quarter and hope to strengthen that in 2H, 2022.

• McDonald’s (MCD) missed estimates but had a strong same-store sales growth of 12.3%. US same-store growth was down from last quarter but still strong at +7.5% driven by the increase in menu prices. MCD is firmly focused on their plan to build the world’s largest loyalty program after their successful launch last year and this could be a real winner for them. The company is convinced that this is a step towards driving digital adoption, while they continue to fight labor shortages and food inflation, which they expect to continue into 2022. They also said McPlant had a successful pilot in 250 restaurants in the U.K. but, China overall remains a challenge with Covid related lockdowns.

• Caterpillar (CAT) beat top and bottom line estimates yet, their stock dropped following the earnings report. While they had strong demand over the quarter, the company’s margins have taken a hit due to increased costs from freight and supply chain constraints. They also warned of poor sales in China due to the increasing volatility and regulations in the real estate market. While there remains pent-up demand from projects that were put on hold due to the pandemic, the rate hikes this year could decrease that demand due to slower investment into large-scale projects.

• MasterCard (MA) and in fact Visa (V) as well, had strong earnings, beating estimates by over 6%. Pent-up demand for travel and entertainment (T&E) spending and the decrease in travel restrictions helped increase the company’s revenue +19% above the pre-COVID level of Q4, 2019. The company expects this to continue as cross-border spend resumes. They’ve also got a few initiatives that should add to their growth such as a co-branded card with JPM and Instacart, a collaboration with Coinbase to enable customers purchase crypto and NFTs and a continuation of their installment payment program to keep up with Buy Now Pay Later (BNPL) trends.  

Around the Markets

• Constellation Energy ($CEG) will replace Gap Inc. ($GPS) in the S&P 500, Gap will replace Jack in the Box ($JACK) in the S&P MidCap 400, and Jack in the Box will replace Spectrum Pharmaceuticals ($SPPI) in the S&P SmallCap 600 prior to the opening of trading on Thursday, February 3.

• The shipping companies have been gaining strength over the course of the week with stocks making new Relative Strength highs. A few top stocks in this industry are Danaos (DAC), Star Bulk Carriers (SBLK), Global Ship Leasing (GSL) and ZIM Integrated Shipping (ZIM).

The Week Ahead

Economic Indicators 

• Tue - Feb 01 - ISM Manufacturing Index

• Thu - Feb 03 - ISM Non-manufacturing Index

• Fri - Feb 04 - “Jobs Friday” with Payroll Data and Unemployment Rate

Earnings 

We have the other half of the tech heavyweights reporting next week with Google, Facebook and Amazon, so let’s be mindful.

Closing Thoughts

With US debt at unprecedented levels and the slowing of GDP growth, overcorrecting could spell an immediate recession for the economy. Inflation may be at a 40-year high but I doubt we see ‘Volcker’ reaction to the situation.

Inflation already seems to be peaking with PCE levels this week coming in as expected. Still, Chair Powell has an enormous task of engineering a soft landing for the economy. I really don’t think anyone wants to be in his shoes right now.

Given that the market is still bearish, I would wait before making any drastic moves. For an investor, this is an ideal time to be studying companies to add to your longer term portfolio at target prices. Whether I’m trading or investing, I’m making sure position sizes are small, small, small.

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

Please take a moment to share and subscribe, if you found this newsletter useful.

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, $ZIM, $MSFT, $BA, $CAT as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.