The Weekend Edition # 132 - Antlers on the Horizon

Welcome to another issue of the Weekend Edition!

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Here's what we cover

• Market Recap - Mixed Messages

• Macro - Antlers on the Horizon

• Earnings have a tougher job now

• Closing Thoughts -

• Closing Thoughts - Things aren’t attractive

• Calendars

Market Recap - Mixed Messages

April 29 - May 03, 2024

It was a big week for the markets - we had the Fed meeting, GDP Growth, employment data, and earnings from Amazon and Apple. Most of which seemed to have been taken well by the market.

The US Treasury’s initial summary announcement of upsizing issuances, however, caused some grief earlier in the week. But, we saw a reversal of that price action as Fed Chair Powell came out far more dovish than expected. A weaker unemployment report and Apple announcing a historic buyback of $110B didn’t hurt either.

Going forward, we have over 50% of the S&P 500 market cap exiting the buyback window and even if yields continue to remain higher, we may see some liquidity come back into the market.

Commodities

With geopolitical tensions waning, we’re seeing oil pull back significantly from its highs. This has led plenty to believe that the OPEC+ will continue their production quota cuts into the second half of the year. We still don’t know what they will do but there are some issues to consider:

• Saudi Arabia has spare capacity and their last 3 GDP growth reading have come in negative, i.e., three-quarters of declines led by the decline in oil production. This is because as we’ve discussed earlier, Saudi Arabia bears the largest burden of these production cuts.

• There is widespread evidence that industrial production is returning and that should increase oil demand such that they don’t have to keep the production cuts going.

• Finally, there is also the secular discussion of how AI, Bitcoin, data centers and advances in technology will need higher computing power and therefore, more energy. This increase in demand is a gradual growth story but, a real one nonetheless, and we’re likely going to see that drive oil prices higher on sentiment alone.

This last issue also gives us reason to be bullish on Copper and Silver, both metals that are needed in the technology race. While both of these have already rallied over 20% from their lows in February, we don’t think it’s done.

Some of the charts in the recap section have been sponsored by Koyfin. We have a special discount of 15% for MacroVisor readers for any new sign-ups to Koyfin. To take advantage of this promo please sign up here - Koyfin MacroVisor Discount

Macro - Antlers on the Horizon

“I don’t see the stag or the flation” - Fed Chair Powell

Immortal words that will go down in history, perhaps as yet another mistake. Over the past few months of higher inflation, and particularly after the slower growth reading in GDP, the word being thrown around is “Stagflation”.

This Friday sealed the deal… and now we have all three conditions heading towards stagflation.

☑️ High or Accelerating Inflation

☑️ Low or Slowing Growth

☑️ High or Increasing Unemployment

None of the data that we got on US employment this week points to a particularly tight labor market.

• Non-farm payrolls rose by 175k, notably slower than +303k last month. There were also -22k in revisions from previous months. This takes the three-month moving average lower after four consecutive increases. Job gains in Government were the slowest (another sign of slowing government spending).

• Unemployment Rate inched up to 3.9% p.a. and we are now only 0.1% away from the Fed’s projection of 4% for this year.

• The Quits Rate is now at 2.1%, falling below pre-COVID levels for the first time this cycle. Fewer people quit their jobs in times of distress and when there are fewer options available. A falling quits rate shows a cooling labor market.

• Job Openings still remain at 8.48 million, far above pre-pandemic levels but, are trending lower. ⤵️

In line with the Fed’s thinking, we’re now seeing a labor market this is definitely cooling and this brings us closer to Fed Rate Cuts. A sharp rise in unemployment will definitely push us over the low bar for rate cuts. The likelihood of July still being the timing of the first cut, is rising.

So now the question is, what happens if the Fed starts cutting rates because of rising unemployment, while inflation is still increasing?

Apart from the GDP numbers, we’ve now got ISM Manufacturing and Services prints coming in lower, particularly with regard to “New Orders” which are usually indicative of future growth. Add that to the massive fiscal debt in an election year, and we’re not likely to see the government be able to manage the growth rate through unrestrained fiscal spending.

And now the Fed is slowing down on tapering the balance sheet which simply means that there will be more liquidity in the system and therefore, more money chasing fewer goods.

Economic growth is not part of the Fed’s dual mandate; inflation and unemployment are. So which does the Fed choose to balance - inflation or unemployment?

Given the sticky inflation scenario, we may end up in a situation where the Fed defers rate cuts and allows unemployment to exceed their projections before they can cut. This could definitely weigh on growth and employment in the interim. However, the level of unemployment will still be relatively low compared to historical standards.

Choosing the opposite and cutting too soon though, will likely be a policy mistake. At this stage, without inflation completely under control, a rate cut could just fuel inflation further and cause expectations to even become unanchored.

Earnings have a tougher job now

Blended earnings growth has come out to 5% YoY for Q1, 2024, thus far. All things considered, earnings are in a good place. As far as revenue growth goes, the S&P 500 companies have reported 4.1% YoY growth so far.

Many of the price targets exceeding 5000 for the S&P 500 were based on:

• A deceleration in inflation and therefore, Fed rate cuts would lead to lower yields.

• Lower yields would allow for multiple expansions. This multiple expansion would be across the board. We are currently at multiples of 20x+ on the S&P 500 but, that’s being led by the MegaCap Tech companies. The S&P 500 equal weight still has a multiple of about 17-18x. The idea was that with lower yields, we would wind up in a position where the market broadens out and multiples expand for the entire market, as multiples contract for the Mega Cap Tech.

• Earnings growth of ~11% which could support those price targets, given multiple expansions.

Now please look at the chart below:

The problem we now face is an environment, where rates may remain higher for longer. When rates are driven by growth, earnings can also grow and offset higher yields. But, when rates are driven by higher Fed policy and accelerating inflation, it weighs on multiples and earnings growth.

Assuming that we don’t see much broadening out of the market and multiples start to contract on MegaCap Tech as well, we may end up with multiples of 19x, if I’m being generous.

This would mean, that to support a price target of 5000+, we would need earnings growth of about 20% YoY for the S&P 500 companies. So earnings have a much tougher job now.

We’re already seeing a slowdown in the ISM New Orders which tend to lead corporate profits, so we should probably temper our expectations to a certain extent on earnings growth.

Whether it actually ends up being the case for the market, remains to be seen.

Articles this Week - In case you missed it

Closing Thoughts - Things aren’t attractive

This weekend Berkshire Hathaway held their Annual Meeting for shareholders. It was the first one after Charlie Munger’s passing in November. The tribute video they did for him was absolutely masterful and worth watching. It’s available on YouTube.

But, what else did Warren Buffett say?

Berkshire sold another $115m in shares of Apple - about 13% of their stake. It is still their largest holding by far. So why did they sell?

To potentially avoid taxes.

Buffett is of the opinion that US Taxes will increase down the road to fund an increasing level of US fiscal deficit. “The Government owns a percentage of our earnings…not the assets… They can change that percentage. With the current fiscal policies, something has to give and higher taxes are quite likely. They may decide that they don’t want the fiscal deficit to be this large, because it has important consequences… and they may not want to decrease spending.

No one would owe 'a dime' of federal taxes if other companies paid fair share”

He wants to continue to build the cash position because they “don’t know how to use it effectively at 5.4% and we wouldn’t use it even if it was at 1%. Don’t tell the Federal Reserve that!

Things aren’t attractive!”

I know that Buffett has different standards for buying companies, now that he’s gotten to where he has. However, there’s always wisdom in what he says. When we look at deals in the market, the amount of leverage on the balance sheet, and the kind of returns we want to achieve, it’s very different today in the era of “higher-for-longer”, and suddenly cash becomes a far better bet.

Have a great week ahead!

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

Calendars

US Earnings Calendar

US Economic Calendar in Eastern Time (Source: Trading Economics)

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.