Wentz Weekly: Finding The Bottom Is A Process

Wentz Weekly Insights
Finding the Bottom Is A Process

For the first time in eight weeks, US stocks were able to end the week with a gain. In fact, it was the first time since late 2020 that all four major indices were able to gain at least 6% for the week, and the S&P 500 finished 9.1% off its intra-day lows the Friday prior. There was no single headline driving markets higher but a number of items may have contributed including coming off of depressed sentiment and oversold levels, the reopening in Shanghai after Covid related lockdowns along with government support for its economy, solid retail earnings reports (after a low bar was set from disappointing results the week prior), falling Treasury yields and the breakeven rate (reflects inflation expectations), a less hawkish tone from Fed officials, and solid economic data on the consumer.

While the markets have moved almost 10% off the bottoms, and while we do not know if the low set two Fridays ago is the bottom, we want to emphasize the bottoming is a process rather than an event. History tells us bear markets see several rallies during the bottoming process. We are currently in one, and the last time a bear market has only seen one rally was 1948.

Stocks were coming off poor sentiment, given a more hawkish Fed, 40-year high inflation, a slowing economy, disappointing earnings due to higher costs, and Covid concerns in China. Since then, China has shown improvement with officials removing most lockdown measures, and signs of improvement in Beijing where the latest wave has occured, lifting sentiment around the world on the Covid front.

The tone for the retail sector, which was coming off a 9.4% weekly decline, was set by two high-profile misses from Walmart and Target due to rising costs that were pressuring the bottom line, along with a negative impact from a shift in consumer’s spending patterns (to things like food, away from higher-margin items like electronics). But last week’s earnings reports gave a more upbeat view of the sector and consumer. A number of companies like Macy’s, Ulta Beauty, Nordstrom, Dollar General, and Costco posted better sales figures than expected and gave more promising forecasts with Macy’s CEO saying “while macroeconomic pressures on consumer spending increased during the quarter, our customers continued to shop… We saw a notable shift back to occasion-based apparel and in-store shopping, as well as continued strength in sales of luxury goods.”

Comments from Fed officials provided a less hawkish outlook as well. Minutes from the Fed’s most recent meeting hinted the Committee would pause rate increases to assess the effects of higher rates, while Atlanta Fed President Bostic said he would like to a pause in September, after back-to-back 50 basis point increases in the policy rate. The market’s expectation of future interest rates has come down slightly over the past couple of weeks. These have corresponded to a move lower in Treasury yields – the 10-year Treasury yield has fallen from a high of 3.17% three weeks ago to 2.74% Friday, helping push bond prices higher. In addition, the 10-year breakeven inflation rate, a measure of expected inflation, has fallen from over 3.0% at the end of April to near 2.5% last week. Both of these have supported the “peak inflation” and “peak Fed” narrative.

All of this is to say markets were coming off very depressed sentiment with oversold levels that led to contrarian buy signals for some traders and a bounce from the low. The issues we had two weeks ago still face the markets and economy today – most importantly decades high inflation that shows no signs of getting back to the target of 2% and a more hawkish Fed that is looking to get rates above neutral over the medium term. While we do not know if the markets “bottomed” two weeks ago, we do continue to expect heightened volatility and in this environment favor value names with pricing power and those that tend to be more defensive.

Week in Review:

US Stocks opened the week on Monday in rally mode with the major indices finishing near the highs of the day. There were several merger and acquisition headlines (see company news below), news that the White House is considering lifting Chinese tariffs to help inflationary pressures, and lockdowns easing in Shanghai, but no one catalyst that sent stocks higher besides oversold conditions. For the day the S&P 500 finished higher by 1.86% while bond yields moved higher as the 10-year yield finished at 2.86%, up from 2.79%.

Tuesday’s trading began with news headlines dominated by Snap’s warning that revenue and profits will be lower than its forecast provided one month ago due to a further and faster deterioration of the macro-economic environment than previously expected. The digital advertising space saw the most selling pressure as a result, followed by retail due to another batch of decent earnings results but disappointing guidance over costs concerns and sales slowdown. In addition, new home sales for April saw a massive decline, falling 17% for its largest drop in years, leading to additional concerns about an economic slowdown. Although stocks were lower for the whole session, they finished off the lows with the S&P 500 down 0.81% and the Dow managing to move positive, finishing higher by 0.15%.

Wednesday was met with more earnings reports that were more of the same – solid results but downside guidance, this time from Dick’s Sporting Goods. A lot of focus remains in China due to the spread of Covid in Beijing along with an official at the SEC making remarks about there still being “significant” issues when talking about the lack of transparency from US-listed Chinese companies. In the afternoon the minutes to the Fed’s May meeting was released that showed support for 50 basis point increases and the next couple meetings, but did not strike as much of a hawkish tone as was feared and that helped stocks move higher for the day. Small caps and growth were the best performers, both up over 1.5%, while the S&P 500 gained 0.95%.

Headlines were quiet on Thursday, but peak Fed hawkishness and several earnings reports led the markets higher at the open. However, Chinese Premier Li said things were worse now than two years ago on the Covid front while Alibaba reported a strong quarter, overcoming many logistic issues and Covid lockdowns. The number of stocks that advanced on the day was at its highest rate since September 2020, leading some to believe the bottom was made however, volume was much lighter than the recent average. Yields remained steady and the S&P 500 closed higher by 1.99%.

Markets got a boost Friday morning as the personal consumption expenditure price index, The Federal Reserve’s preferred inflation gauge, showed a deceleration in inflation. In addition, income rose as expected driven by wages and salaries, while spending was higher than expected and remains slightly above the pace of inflation (details below). Several more retail earnings reports released exceeded expectations. US stocks had another very solid day, with the S&P 500 up 2.47% on no substantial news headlines and low volume as investors head into the holiday weekend early.

Treasury yields held steady for most of the week, the 10-year opened the week at 2.79% and finished near 2.75%. Crude oil saw a small move lower the beginning of the week before settling about 2% higher for the week. US stocks finished higher across the board with the major indices finishing as follows: NASDAQ +6.84%, S&P 500 +6.58%, Russell 2000 +6.46%, and Dow +6.24%.

Recent Economic Data

• There was a dramatic drop in new home sales for April. The month saw a massive miss, with new home sales falling 17% in April to an annualized rate of 590,000 homes versus a consensus of 750,000. Sales are now down 27% from a year ago. Remember new home sales reflect contracts signed in the month, not closings (which gives you the most recent indication of the housing market). The median price of a new home was $450,600, up 3.5% in the month and 19.6% higher from a year ago. The monthly payment of a new home is now $450 more than in January, a staggering 42% increase in just four months, thanks to higher home prices and interest rates. Rates started the year at 3.11%, beginning of April was 4.88%, end of April was 5.41%. The supply of homes improved 50k to 444,000. Months supply (how long it would take to sell the current inventory) improved (mostly because of the lower sales pace) from 6 month supply in March to 9 month supply in April. A balanced market is 5-6 month supply. But this included homes where construction has not started yet or is still under construction. Also starting to see more cancellations based on commentary. Those that put money down several months ago are second guessing now because of affordability – it takes 6-8 months to get the home once you commit/sign a contract.
• Durable goods orders, an indicator of business investments, grew 0.4% in April slightly ahead of expectations, driven by aircraft, machinery, and primary metals. Non-defense core capital goods orders, a direct input to GDP for business investment, rose 0.8% in the month. Durable goods orders have recovered sharply from the depths of the pandemic, up 67% from the lows, and are now 15% above pre-pandemic levels.
• The Federal Open Market Committee minutes from its most recent May meeting show members support 50 basis point rate increases at the next couple of meetings, and beyond that moving to a more restrictive stance (moving rates above neutral).
• First quarter GDP was revised down from a 1.4% decline in the initial estimate to a 1.5% decline in the revised estimate. The downward revision reflects a downward revision to inventory growth and residential investment, partially offset by a upward revision to consumer spending. To recap, first quarter was not as bad as the headline suggests – the decline was due to a surge in imports (imports subtract from GDP because it uses net exports, i.e. exports minus imports), which contributed a negative 3.2% to the headline number. Private domestic purchases, a better measure of true US growth, was up 2.7% annualized in the quarter.
• Unemployment claims fell 8k to 210,000 for the week ended May 21. The four-week average remains near 52-year lows at 206,750. Continuing claims were 1.346 million, up 31k from the prior week and averaging 1.347 million over the past four weeks, the lowest since 1970 (when the labor market was half the size it is now).
• Per the Bureau of Economic Analysis’ monthly personal income and outlays report:
• • Americans’ income rose 0.4% in April on average, falling short of the 0.6% rise expected. The important wages and salaries category rose 0.6%, closer to the expected increase, and is 11.6% higher than a year ago. Compared to pre-pandemic levels, wages and salaries are 18.1% higher, while consumer prices (via the CPI) are up 11.4% over the same period, meaning real wages (after adjusting for inflation) are up almost 7% since the pandemic started.
  • Consumer spending rose 0.9% in April, higher than the 0.7% increase expected, and follows an (upward revised) 1.4% increase in March. Spending is up 9.6% from a year ago, while CPI is up 8.2%, giving us a “real” spending growth of 1.4%. Both categories were strong, but the shift to spending more on services continues – services spending up 0.9% in the month and 10% from a year ago while goods spending rose 0.8% in the month and 8.9% from a year ago.
  • More importantly from the Fed’s perspective, its preferred inflation gauge (the PCE price index – personal consumption expenditure) rose 0.2% in April, rising 0.3% excluding food and energy, and is 6.3% higher than a year ago, while core prices are 4.9% higher than a year ago, both falling from March’s levels. It is positive seeing a deceleration, however inflation is still in the system and is still much higher than what the Fed and markets are targeting.
• Consumer sentiment continues to deteriorate according to the latest University of Michigan survey for May. The headline index fell from 59.1 to 58.4, the lowest since 2011 when it was 55.8. The current conditions index fell from 63.6 to 63.3 and the expectations index fell from 56.3 to 55.2. Near-term inflation expectations moved slightly lower from 5.4% to 5.3%.

Company News

• Animal health company Covetrus announced it has agreed to be acquired by a private equity firm. The PE firm will acquire all outstanding shares at $21/share for a $4 billion deal that includes debt. The transaction reflects a 39% premium to the 30-day average share price.
• Wendy’s moved higher last week after its largest shareholder, investment management firm Trian Partners, proposed a potential acquisition to Wendy’s board. No price was discussed in the filing.
• Snapchat parent Snap warned it expects Q2 revenue and EBITDA to be well below its previous forecast that was issued one month prior, saying “Since we issued guidance on April 21, 2022, the macroeconomic environment has deteriorated further and faster than anticipated.” In addition, in a memo to employees, it said it would slow its hiring for the remainder of the year.
• As reported by the FT and WSJ, Broadcom is working on a deal to acquire cloud computing and virtualization software company VMWare (an old Dell subsidiary) in a mostly stock plus cash deal. The WSJ is reporting the deal could be worth around $60 billion or $140/share (VMW was $95/share pre-announcement).
• AMD unveiled new chips and motherboard including its new CPU that it says is 30% faster than Intel’s latest CPU.
• In its investor day event, JP Morgan raised its 2022 net interest income guidance and said it expects to benefit from single-digit loan growth and rising interest rates as the Federal Reserve turns more hawkish. Banks benefit as interest rates rise because they are able to write loans at higher rates, creating higher net interest income.
• Following Apple news last week that it wants to increase production outside of China, Nikkei reported Apple is behind on its production schedule, particularly for its iPhone, due to Covid lockdowns in China and could cause delays in distribution. The report says Apple has asked its manufacturers to speed up their production to make up time.

Other News:

• European Central Bank President Lagarde said it is starting down the path of policy normalization and may have positive interest rates by the end of the third quarter. The ECB’s asset purchases will end by the beginning of Q3 and a rate increase will follow, according to the central bank’s forward guidance. Lagarde also discussed the prospects of raising rates over neutral, saying if appropriate to do so then they will. Later in the week, another ECB member went on the record about the possibility of a 50 basis point increase in benchmark rates.
• President Biden has taken into consideration the option of removing some China tariffs in an effort to ease inflationary pressures. The administration remains split on the issue, with some believing it will help, while others see it as the US appearing weak to China. The US Trade Representative Tai has pushed back on the issue, wanting to keep tariffs in place to maintain leverage. Also, the administration announced a new economic agreement with 12 Indo-Pacific nations in an attempt to counter China’s influence. Separately, when asked a question, Biden said the US would defend Taiwan militarily if China were to invade, but the White House had to later walk back those comments, saying the US policy has not changed.
• Saudi’s energy minister said OPEC+ plans to work an agreement that continues to include Russia, saying the world should appreciate the value of the OPEC+ alliance, reiterating its support for Russia as an OPEC+ member. The FT article also points to the fact OPEC members have consistently failed to meet production quotas. Separately, China has increased its purchase of Russian oil.
• Economic data and recent earnings reports are suggesting slowing economic conditions and the futures market has taken note. After several months of an increasing probability of higher interest rates, traders are now reducing rate increase projections. Earlier this month, futures reflected the expectation of ten 25 basis point increases, now that expectation has dropped to around seven increases.

Did You Know…?

Americans’ Savings Rate:

Americans’ savings rate has been in a down trend since the worst days of Covid and continue to fall, according to the latest data by the Bureau of Economic Analysis. The savings rate is defined as personal income minus personal outlays and taxes, or in other words, the income left over after people spend money and pay taxes and is a good indication of Americans’ financial health and predictor of consumer behavior and economic growth. The savings rate in April was 4.4%, the lowest level since 2008 when America was in the depths of the Financial Crisis. For comparison, the savings rate averaged 7.1% from the end of the Financial Crisis to the beginning of the Covid pandemic (2009-2020).

WFG News

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