The Weekend Edition # 81

Welcome to another issue of the Weekend Edition. 

Thank you to all who’ve read and welcome to all the new subscribers this week!

Here’s what we cover:

• Market Recap - Q1 recap, Opec Announcement

• Macro - The Business Cycle

• Earnings - Lululemon Athletica

• Articles of the Week - Industrials and Materials

• The Week Ahead - Economic & Earnings Calendar

• Closing Thoughts - Seasonality vs. Earnings

Let’s dive in ⬇️

Market Recap - 27 Mar - 31 Mar, 2023 📉📈

It was quite an end to the quarter with the markets ripping higher and Nasdaq now closing over +20% above its 52-week lows. The media is calling this a bull market and there’s speculation that we may have entered a new bull market. But, there is still need for some caution here if you look at the macro environment.

We’re still in a rate hiking regime and we’re yet to see the earnings for this quarter which is projected to be much lower than even expected. What we’ve been talking about - an earnings recession - is yet to manifest and this second quarter of the year is likely to seal the deal.

Nevertheless, it’s interesting to see that the Nasdaq has actually outperformed the S&P500, when last year it couldn’t catch up throughout the year. This was in part because of the beating the banks took last month but, it would also seem that people have started to consider this an opportune time to buy the dip in tech. Not surprising, we have tech, communications and discretionary leading the sector rally for the last quarter. This continues to bring about a very “risk-on” feeling in the market.

Friday was certainly an interesting day with a confluence of factors driving the rally:

• JP Morgan Quarterly Collar Roll

• Quarter End

• Month End

• Week End

• PCE Inflation came in softer / inline

It’s hard to imagine that just a few weeks ago we were on the brink of a major credit event turning into a contagion. The market was ripe with speculation about banks failing and we were seeing recession trades being priced in with Gold crossing $2000 and WTI Crude falling below $70.

Crude Oil has made more than a full recovery since then as concerns over the banking sector declined. Given the speculative positioning of money managers, there seems to further upside in oil unless we get another scare in the banking sector.

As I write this, Bloomberg just announced the news of OPEC cutting production by 1million barrels. This was a given. I’ve been discussing this on various forums. I’m based in Dubai and I can tell you with some degree of certainty that OPEC will try everything possible to keep the price of Brent Crude above $75.

Most economies in the Middle East, including Saudi Arabia and the UAE, are pegged to the US Dollar and, we’re seeing rates rise in tandem with the US. Given the higher rates and the level of debt burden, these economies need oil prices to remain buoyant so that they can remain stable.

The size of cuts announced:

Macro - The Business Cycle 🌎

This is an interesting chart from JP Morgan Private Bank showing us a breakdown of the business cycle and what we should expect under each scenario.

JP Morgan’s view is that the US economy is currently in the mid-cycle phase and they predict that it will move into late-cycle by the end of the year.

If you look at the recession bars in the chart above, most of them cover the index when it is mid-cycle. However, the chart also shows us that most of the recessions occur when the index is moving from late- to mid-cycle to early cycle. Given where the index is currently, it seems to suggest we are going the opposite direction and therefore, a recession isn’t likely.

But, this time may just be different. We have an interesting set of factors playing out. The Fed hiking cycle doesn’t seem to be ending with a drastic cut, the unemployment level still remains remarkably low, we’re experiencing quantitative tightening and inflation is a major factor that hasn’t played a huge part in the economy since the early 80s.

While in the shorter-term we’re experiencing market rallies, in the longer term, given everything that’s going on it doesn’t seem like the economy will avoid a recession. We’ve already seen somewhat of a credit event take place and with tightening lending standards and negative growth in money supply, we’re like to see further stress in the economy.

Whether something breaks or not remains to be seen. One thing I can tell you though, is that we’re living in a time that will make the economic history books.

Earnings 📝

FactSet Earnings Summary

Lululemon Athletica  

Lulu reported a double beat - putting up Adjusted EPS of $4.40 vs the estimate of $4.26. GAAP EPS however, came in much lower at $0.46/share because they decided to write-off $410m of the $500m acquisition price paid for Mirror. This is perhaps a good step and Lulu is taking the loss early here.

Revenues came is very strong at $2.77B vs. the estimate of $2.70B. The brand remains a winner and has a strong franchise which they are expanding in China. Inventory however, still remains an issues. They are still up +50% YoY on inventory and the recent mark downs and discounts led to a decline of 3% in Gross Margin.

Despite having too much inventory, the company is still guiding to a margin increase for Q1, 2023 by +2.9% to 3.2% and +1.4% to 1.6% for the full year. This implies that they’re likely to be selling at full prices again. With the current macro environment and the pressure on the consumer, this seems unlikely. I think Lulu’s guidance here is a bit optimistic, and unless this is revised down prior to the next earnings, we might just see some pain there.

While Lulu has a strong story, the stock price is now up over +13% on the earnings result and it would be prudent to wait for the price to settle and Lulu to ride out the next quarter for any new buyers. I would not be chasing the stock here.

Article of the Week 📖

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The Week Ahead 📅

Earnings Calendar 

Economic Calendar in Eastern Time - April 07 is scheduled to be a market holiday

Closing Thoughts - Seasonality vs. Earnings 💭

After a serious run up like we had on Friday, there is some reason to think that we will see somewhat of a reversal come next week. But, the market may not be done rallying in the short term, over the next two to four weeks.

April has historically been a bullish month for stocks but, part of the reason for that is also the start of earnings season which has historically given stocks a boost. 2022 wasn’t such a great year and it remains to be seen what this year brings.

But, caution is still warranted. Earnings season starts by mid-April with the banks, who will be under tremendous scrutiny this time around and unless there are positive signs signaling safety, banks just may take a beating.

There’s no doubt we will see a drop in earnings growth but, the question still remains as to whether stocks react positively or negatively. Whether April will be a positive month, will depend on who wins the battle - seasonality or earnings.

Here’s wishing you safe investing.

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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 or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.

Full disclaimer: https://ayeshatariq.substack.com/about