Good Evening:
Markets broke an 8-week losing streak. The beginning of the week was tough, and not much has changed regarding the many risks facing markets other than inflation appears to be cooling. Despite this much-needed relief, let’s also remember that Chairman Powell said, “This is not a time for tremendously nuanced readings of inflation. We need to see inflation coming down in a convincing way. Until we do, we’ll keep going.” Inflation is still at multi-decade highs. Our Head of Research, Tom Lee, will dive into inflation and shed some light on what we can expect in terms of inflationary pressure in the next couple of months.
Notably, there appeared to be some green shoots in mega cap tech, which is incredibly essential for the overall level of the indexes, given the prodigious market caps of many of these firms. Apple has a new phone coming out. The economy is changing in major ways. For example, what port do you think has the highest dollar value of goods that pass through it? We bet your first bet wasn’t Chicago, but many high-end products are now being shipped by plane instead of by freight ship. While the logjams have been alleviating, when China’s lockdowns end, the issue of traffic jams at sea may again re-emerge. Apple sends all its products to Chicago, believe it or not. Other high-end items being shipped by plane have also been flooding O’Hare airport.
So, markets had a decidedly better week than the last eight. Is the bottom in? There is still apprehension, but investors appeared to take some solace in the low likelihood of a 75-bps hike after the Fed minutes. The FOMC members suggested they would likely have two more 50-bps hikes ahead, which the market largely had already priced in. FOMC members appeared more willing to take the Federal Funds rate above 2.5% on the hawkish side. This is the level that most economists agree has a neutral effect on growth. The FOMC said they were open to a higher rate that would have a restrictive impact on development if needed to curb the inflationary pressure.
So, is the bottom in? Markets have come down quite a bit, and this bounce should have been expected. In our estimation, while the risk/reward has improved significantly given the comedown in prices with a medium-term to long-term horizon, the coast is not clear. Our team respects this bounce, and we have evidence suggesting it should continue in the short term. The upward move went above resistance levels.
Our Head of Technical Strategy, Mark Newton, had his eye on a level of upside resistance that has been broken. Our Head of Quantitative Strategy, Adam Gould, has seen his short-term Reddit-based sentiment indicator turn up from the extreme pessimism he saw last week. This short-term contra indicator suggests that the rally should continue over the next few days or weeks. However, Mr. Gould still considers the market is overvalued relative to debt, which means there is still a high possibility for additional downside once this bounce has culminated.
Quantitative tightening will begin at the next Fed meeting. There is still a cornucopia of risks plaguing sentiment and causing a buyer’s strike in markets. However, we are not getting the low dispersion converging correlations that usually typify the forced liquidation and exhaustive selling that brings valuations low enough to attract buying. So, it is an environment where disciplined stock-picking could get you more alpha than usual.
This has been observable in retail, where it appeared to be a tale of two consumers in some ways. Target, Gap, Dicks, and Walmart had dismal earnings reports that resulted in their largest price drops in decades. They reported rising inventories and consumers changing spending behavior based on inflation. Nordstrom’s, Ulta Beauty, and Macy’s, which have more affluent consumers, beat expectations. Of course, effective and competent management with a clear vision and strategy is essential and distinguishing in these treacherous times. It has differentiated winners from losers.
Nvidia reported strong numbers on the top and bottom line. However, they guided lower on revenue than Wall Street was expecting. The stock sold off in after-hours, but it closed well into the green. It rallied further on Friday after the strong inflation numbers as well. Nvidia is a company with an extraordinary management team and is pretty central to the future of AI, which benefits virtually all industries. We think this is a unique company that is extraordinarily well-managed. So, we could caution about using this turnaround after weak guidance as a definitive signal that the coast is clear.
Similarly, Broadcom announced one of the largest technology deals of all time; a $61 billion cash-and-stock deal for software firm VMware. The only two larger deals were Microsoft’s recent acquisition of Activision Blizzard and Dell’s acquisition of EMC. Only time will tell whether they can convince that the marriage of this software business with their chip business is something investors will pay a premium for. Nonetheless, it is a notable deal. As we enter a lower-liquidity environment technology firms with a lot of cash may be looking to buy strategic targets while valuations are low.
Rallies are great, but you should always look at them with a skeptical eye when the macro environment is as fraught with risks as it is today. Our Head of Technical Analysis says that if you’re so short that you could fall into your boot, that this would probably be a good time to cover your shorts. Remember there are many ways to mitigate downside risk as well. Remember too, there’s still the unfortunate conflict in Ukraine that is fraught with potential black swans. Former Secretary of Defense Ash Carter assigned a 2/3 probability that the conflict drags on and ultimately becomes frozen. Within the remaining 1/3 there are possibilities for unexpected bearish and bullish outcomes. The use of weapons of mass destruction or an attack on a NATO country sit somewhere in the single digits. Obviously, the path of this war will influence markets greatly.
When the going get’s tough, the tough fall back on discipline and process in markets. When there are so many problematic catalysts in markets it’s important to ground yourself in rational decision-making. We strive more than ever to provide you with the data and grounded process you need to decipher the signal from the noise in treacherous markets. We hope you all have a beautiful Memorial Day weekend with your families. Let’s contemplate the sacrifices of our braved armed forces over our history. Without their bravery and sacrifice, we might not have any markets to talk about.
“The brave never die, though they sleep in dust: Their courage nerves a thousand living men.” Minot J. Savage
Happy Memorial Day Weekend!
