The Weekend Edition # 93

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 - Month End / Quarter End

• Macro - Terminal Rate Creep

• Earnings - FedEx

• The Week Ahead - Economic & Earnings Calendar

• Closing Thoughts - It’s better to know!

Let’s dive in ⬇️

Market Recap - 19 Jun - 23 Jun, 2023 📉📈

A tough week for the markets - it felt almost like someone let the air out of the tires. But, we knew positioning was stretched after the run the market had in the previous few weeks and after the June OpEx on Friday, it was time for a breather.

The market positioning still remains stretched and we have the end of the month and end of the quarter next week. This is when funds rebalance their books and it’s quite likely this is what we’ve been seeing last week and that we will see some further selling into the month-end, because equities have run up significantly causing an imbalance.

The rotation during the week seemed to suggest quite a bit of risk off. It also suggests some profit taking and rotation to defensives as we head into the 2H of the year, with the Fed signaling two more rate hikes and global Central Banks continue with their hawkish tone.

Commodities have been mixed, with precious metals, industrial metals and oil looking weak. The Ag complex was mixed as well, with Wheat and Soybeans faring relatively well for the week.

After the attempted coup in Russia yesterday, there was some worry about commodity prices surging because of the conflict. However, now that the conflict is seemingly resolved, it remains to be seen what happens. It’s like the market will still remain turbulent in overnight trading and being cautious would be the right move.

The signals we’re getting from the commodity markets are quite interesting, with oil down and gold down. Usually, one would be a risk on indicator and the other would be a risk off. But, it’s likely delivering just the right message - the market remains mixed. We’re seeing the same with bonds and equities - with one pricing in a recession while the other just doesn’t seem to care.

Macro - Terminal Rate Creep

The fight against global inflation continues, with central banks in developed markets not just resuming hikes but hiking at higher levels.

Companies have used pricing power to offset the increase in wage growth leading to better than expected margins. But this in turn has fueled inflation. The tightness in the labor market and wage growth has allowed people to continue with consumption to a large extent even at higher prices. This is not just true of the US but also in the UK.

We’re also seeing a resurgence in home prices that will likely price out buyers in addition to the higher level of mortgage rates. This could very well lead to increases in rentals and therefore, higher shelter inflation.

The activity from the services sector is likely to wane at some point reducing core inflation. But, judging by what we’re seeing it will take a while before it heads down meaningfully. JPM estimates a 3% global core inflation for 2024. Headline will depend largely on energy costs. While the proposed cuts by OPEC+ haven’t had a significant impact as yet, there is tightness in the oil market and demand is likely to be higher than supply, as the cuts start to take effect. This could very well mean higher energy costs in the second half of the year. There remains confusion whether the Fed’s last meeting was a pause or a skip. We don’t know. No one knows. But Chair Powell insists further tightening is required, and said so before Congress last week as well. We can’t help but wonder whether the pause was simply to dampen the effects of Treasury issuances to rebuild the TGA. After all they have a massive quota to achieve by the fiscal year end in Sep 2023. It also stands to reason that a one-month pause, 15-months into the Fed’s tightening cycle will tell us nothing about how “the long and variable lags” are taking shape. These long and variable lags usually take 12-24 months. Over in Europe, we saw a technical recession but that didn’t seem to be as damaging to inflation as one would think. That’s actually a little scary! The services sector and employment remains strong there as well while manufacturing has borne the brunt of the economic decline. High energy costs that plagued Western Europe last year in particular, continue to dissipate and this should have been a boost for manufacturing activity, but we just see the PMIs dwindle. None of this however, has had any effect on the ECB’s resolve to keep hiking.

We saw core and core core inflation numbers come in hotter than expected in Japan, while headline inflation declined. This has given rise to the idea that the BoJ may tweak their Yield Curve Control and easing policies during the next meeting in July, particularly after the wording for forward guidance was amended in the last meeting. This next meeting is also when their economic forecasts come out, and we will keep an eye out for whether inflation forecasts change.

The inflation forecast from the BoJ currently shows inflation at 1.8%, still below their target. Real wage growth and real consumption came out negative during the last reading. I personally, don’t believe there will be a change to policy as soon as the next meeting in July.

Terminal rates are now creeping higher. There are those who still remain conservative that the Fed has likely paused because the Federal Funds Rate is the highest rate among developed market countries. But, they’re still pricing in higher rates for the Eurozone, UK, Canada and Australia.

It would seem that as long as countries believe the fight against inflation is not over, they will keep hiking. The question remains, when do we see enough?

Earnings Highlights - FedEx 📝

The major earnings news this week was FedEx. After last year’s warnings on the state of the global economy, FedEx took preemptive measures to heavily slash costs and reorganize their operations. Unfortunately, it would seem that there’s still more work to be done.

The company beat on Q4 earnings but missed on revenues, citing lower demand. Revenue fell 10.1% YoY to $21.93B. However, it looks like their previous cost cutting measures are bearing fruit as their earnings came in better than expected.

The stock fell on news that company would be facing ongoing demand challenges and will have a tough first half.

There’s been a decline in parcel volumes particularly in the US. This is in line with the fall in goods spending that we’re seeing in the economic data. In response, FedEx is reducing flight hours by -12% YoY and permanently retiring 18 aircrafts. This is a sign that they don’t see demand levels recovering any time soon.

“FedEx Freight revenue was down 18% YoY to $2.3 bln, driven by an 18% decline in volumes. This decline was driven primarily by the slowdown in the market and high inventory levels.”1 

There continues to be excess inventory among retailers and this just means we’re likely to see more discounting and markdowns where retail is concerned.

The Week Ahead 📅

US Earnings Calendar

US Economic Calendar in Eastern Time 

Closing Thoughts - It’s better to know!

The cumulative impact of restrictive monetary policies under the “higher for longer” view will eventually erode wealth causing inflation to decline but will take economic growth down with it. That’s the price most countries will likely have to pay if they want inflation to return to that 2% target.

The path to this won’t be easy and as far as most theories go, they seem to involve some degree of unemployment. The problem with unemployment is that once it starts to rise meaningfully, it can accelerate very quickly.

We see that a recession in Europe hasn’t moved the dial on inflation much and that may suggest that core inflation may be much harder to fight, than these countries expected. It may also suggest that a much deeper recession may be required.

We will continue to monitor the data so that we have some degree of preparedness for when this happens and for when things turn for the better. Even though the economic data hasn’t been very encouraging for the last few months, I still think it’s better to know than not know.

Here’s wishing you 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 or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.