Market Musings & Trading Ideas

11/7/24

Trump Wins the Election, the Popular Vote, and the Electoral College.

Massive hedging began about a week before the election. There was a pretty steep implied volatility premium that would need to unwind once the results were announced. It always amazes me how much very short-term positioning changes occur, is anyone a long-term investor anymore? What does an investor do when the market they are involved in becomes a raging casino driven by alo’s and 1-month momentum signals? You actively trade around core positions and look for quality companies exhibiting a short-term pullback for “fast-twitch scalp opportunities. If your core equity basket does an average of 13-15% per year over time and you actively trade around this to generate 2-6% per month returns, the combination can generate quite attractive returns. That’s what we do in the Dynamic Brands strategy when the market gives us an opportunity. With algo’s and the popularity of 0DTE index options, there’s always some single-stock volatility to consider for a trade. I’ll list the trades we like on these pages going forward. Remember, we only invest in the 200 brands that make up our proprietary index called, the Alpha Brands Consumer Spending Index. A list of these brands can be found on the Brands tab and the sub-tab showing the Brands Index. We update that list each December to keep our universe of brands tethered to highly relevent blue chip and innovator brands.

The Election:

This is the first time a Republican won both the popular vote and the electoral vote since 2004. The DNC clearly has lost its way and has let the cruise ship sail off course in a dramatic way. Yesterday’s election results is proof. If you want to know what the market thinks of the Trump opportunities, take a quick read of my summary note yesterday where I tell the story using cartoons I created with the help of ChatGPT. That exercise was very fun.

Link: https://catalyst-insights.com/author/eclark/

The Stock Market:

Stocks had the best 1-day gain on an election I think EVER. That tells you have low exposures and positioning was plus it tells you how many hedges needed to come off all at once. There will absolutely be winners and losers over the next 4 years from Trumps policies but for now any real decisions are based on pure speculation. It’s a different world today than it was in 2017. We have massive government debt, much higher inflation, higher rates, and the Fed has just stopped being restrictive on rates. Any aggressive economic activity stimulus will likely drive up inflation and rates which could cause stocks and bonds to get heartburn. Trumps gang has a fine line to walk.

The Consumer:

Household consumption drives every major economy so it’s very important to stay in touch with the data here. We can do that for you, keep reading these posts. We invest in the global household spending and business investment theme through the most dominant brand franchises around the globe. These are some of the most profitable, dominant companies that have ever been created and they have historically been quite good investments. We expect that to continue over time. Leaders that stay relevant and keep innovating generally widen their lead over peers. These are the companies we like to invest in.

MELI Trading Opportunity - 11/7/24

Here’s the notes from last nights earnings report. The stock missed on a few key areas but for good reasons: they were spending to grow further. The market like linear quarterly growth, that is not how the real world works, sometimes a 90 day earnings period gives off signals that mean nothing to the long-term trajectory of the business. When the market over-reacts, growth and momentum investors tend to be the worst offenders of the “sell now, read the print later” approach. MELI stock fell 16.21% on the day with full capitulation-type volume of 10x normal daily volume, they all left at once and they weren’t shy about the sell orders. I took the selloff as an opportunity to trade around the core position by adding more shares. I think I can get 5-10% on the trade by Thanksgiving at the latest. Just how I’m playing it. Here’s the notes from last night:

Mercado Libre Earnings - Miss

We have a playbook to follow where MELI and its growth drivers and demands are concerned, Amazon. MELI is the Amazon and Paypal of Latin America and its the #1 market share e-commerce brand across Latam and growing fast. When you grow fast in a capital intensive business, you have lumpy quarters on occasion, largely due to the cap-ex needs of logistics and fulfillment centers that drive higher volumes and consumer frequency. Tonights quarter showed what happens to some important operating metrics when infrastructure growth is accelerating. I'll cut to the chase, while I never love metrics that re-set lower and the stock drawdowns associated with them, in Meli's case, as far as I can see, this is the normal "spend to build so you can grow further" problem and with some patience, these usually turn into new growth opportunities so I'll likely be patient on this name given its moat is widening and it plays in a part of the world we have little other opportunities to get exposure to. Heres the details:

Missed estimates, gross margins contracting, operating margins cut in half. Solid balance sheet $2.4B in cash. FCF grew much faster than net income, this is a positive. Revenue +35% but cost of revenue +50%. Gross profit grew 16% and operating expenses +44%. Theres your spend to earn later component. They are building more distribution centers in Brazil and Mexico. The moat expands when you build these centers though so metrics will drop initially then vault back later. Then we had the Mercado Pago finance and payments segment show some noise. Ramping up this credit card biz also costs first and drops margins then they get to monetize. Generally, if you trust management to spend to grow, you add more shares in the spend phase when the stock is low. Lending money and making money is the key here. On the surface, it appears they are making bad loans but when you look further, they are seeing much higher transaction volume at the same time. This metric is called NIMAL. Its ok if it contracts but when you see transaction volume rising, this means they are accounting for the new loans up front and will get paid on them down the line. 

Trade Buy Price: $1768

Sell Price in Focus: $1850-1900 

2022 and Earlier Posts Below

Here’s how your “SAFE” money has been performing. And they wonder why our top two holdings are the kings of the Alts mega trend: Blackstone and KKR

Quick update on sentiment - consumer & institutional - hint - it’s still at extremes. Just remember, theres some great gains when things go from absolutely horrendous and expected to stay that way to just slightly less bad!

And they wonder why Sentiment is bad!

If there was a single indicator to watch for the credit markets, Ill take the 5 year investment grade CDS chart, its elevated but rangebound for now

August 24 interesting charts & news

A few years ago I noted the seemingly idiotic strategy of drill drill drill which just flooded the markets with oil and nat gas keeping prices down and risks to balance sheets high, energy companies have finally decided to keep supply rangebound which has turned these companies into free cash flow machines. Thanks ESG, you pushed investment dollars away and now we have higher energy prices for longer. I don’t love investing in oil and gas stocks but as consumer spending goes more to our energy needs, these stocks, their free cash flow, strong dividends and stable predictable growth offer a real inflation benefit. The chart below shows the FCF generation of the E&P sector. Wow, why would companies drill too much when they have become cash cows?

I guess the Covid “pull-forward” of e-commerce was not as sustainable as people thought? Looks like we are mean reverting back to old trends which are still favorable but were unsustainably high as people wanted to get back to being out and about. I look forward to getting some more e-comm exposure now that most have crashed back to reality.

With the likelihood that inflation (the kind that affects our everyday lives) stays much higher than the Fed and consumers are comfortable with for the next few years, is your portfolio allocated for the kind of market we saw in the late 1960’s to mid 1970’s? CPI averaged 6.3% and the S&P 500 was wildly volatile but largely went nowhere? Thats a potential scenario that very few are allocated for. It’s front of mind for our team and the brands portfolio. Here’s what that period looks like. Big rallies, big drawdowns, lots of VOL. Being active was a much better option than being passive like the vast majority of portfolios are today.

August 10 Notes: PEAK CPI RALLY DAY!!! The worst is in for inflation…but the high prices are NOT going away

A few months ago I talked about my gameplan for markets being a 2 stage process. Stage 1: extreme bearishness meets the inevitability of a peak inflation (CPI) reading causing positioning to get re-set and a wicked rally to begin on max oversold. Markets have rallied strongly over the last month as positioning was re-set and participants anticipated better news on inflation. Remember, the best gains often come when things go from horrendous to slightly less horrendous. Maybe today is the first datapoint to allow the late-comers to add more positioning into stocks but it feels like a dangerous game to begin adding more exposure here. 4330 is the real test and downtrend for the S&P 500. Theres a bit of room from todays 4200 to 4330 so I’ll use further strength to add more cash for optionality. Today we got that lower CPI reading (still 8.7%) but new trends start with better readings. Markets are ripping shorts to bis, that pleases me very much.  Maybe we get a few more readings showing CPI easing slightly further but now it likely gets harder from here for bulls. Hence I’ve been raising cash into every big rally day. Positioning has largely been re-set to a more appropriate level and CPI is easing while still being way too high.

On todays CPI report: 3 of 4 of the most important datapoints that make up the inflation report were UP month over month and year over year. Housing, food and wages are sticky and not getting better. Energy prices came down a bit but gas is still too high and hurting consumers. Consumer savings rates have fallen and use of credit cards has risen, 2/3 of the population is having a tough time paying their bills. Discretionary purchases have no choice but to come down for all but the most well-off consumers. That’s why we have very little exposure to brands that serve lower income consumers for now. And don’t get me started on the “inflation fighting” legislation that will be completely benign to our actual inflation.  It’s still going to be a tough slog for earnings and consumers for a while longer.

One month is not a trend but the Empire manufacturing report released Monday Aug 15 was a complete disaster. And remember folks, we haven’t even started to see the real economic slowing from all these Fed rate hikes. High earnings predictability and stability is the style factor I care about most right now.

If home affordability is bad and mortgage rates stay higher, existing home & new home inventory begins to build but it also keeps builders from releasing too much inventory into the system which keeps overall inventory tighter for longer which drives more interest in rental homes. And what firm owns more rental homes than any other in America? Blackstone BX, our top holding by weight.

Stage 2: then reality begins to set in. The reality that consumers have been stretched to the limit and need to slow down spending once summer vacations end. Its coming, I have high confidence in this call. Prices are still high and likely to stay higher than anyone wants.  The next real reality has already started but will gain steam in the quarters that come. More revenue misses are on deck, margin erosion will follow for all but the best brands. Cost cutting will accelerate as companies run fast to try and keep operating metrics stable and high in the face of slowing demand for products/services. Growth is slowing but inflation is still high. Stagflation is a horrible scenario for stocks and bonds. I do not think the market is priced right for an earnings miss, margin erosion off excessively high margins relative to long term history. My base case is stocks, CPI, bonds, interest rates will stay volatile and range bound and at worst, stocks need to probe lower to get the valuations closer to the reality of slowing revenues and margins. Sometimes next year, likely before July 4 we should see the worst of the earnings slowdown and a trough in stocks but that’s a long way out and a lot of things can happen by then. The end to the bear market will be when CPI is under control and stocks reach a level that reflects a trough in earnings. I don’t think we are there yet but price is god so I will watch closely at the next resistance level. 

Fun facts:

Very few investors today, including myself, have ever invested through a period where CPI was higher than normal, the Fed was tighter than normal, rates were more volatile than normal and equities were wildly volatile. The last real period was 1967-1975. Assets were volatile as hell, uncertainty was high, and asset price gains were well below long term average. I don’t think we will see this for as long as we did back then but I do believe the only way to generate an attractive return for the next 12-24 months is by being very active and using cash as your friend when markets get over their ski’s. Today, asset prices have rallied strongly from the lows a month ago, they can rally a bit more but if history is any guide, we should NOT get too complacent about a scenario called “the worst is behind us”. History suggests we all will need motion sickness pills on our desks to combat some wild swings in asset prices and from start to finish, we might NOT have much to show for this sickness from a returns perspective. IMO, the only way out is to trade the wide ranges and gyrate between fully invested and high beta and holding a lot of cash and/or being willing to be hedged at the top end of ranges.

The below chart shows how wild the 1967-1975 period was with volatile CPI. The annualized gains are included. The S&P annualized return was about 3.3% versus about 10% for the 100 year average. The CPI averaged 6.3% which is not dissimilar from what I think we will see for the next 12-24 months. I’m using 4-6% as my base case so maybe stocks average 4-5%, even 6-8% if we are lucky. BUT the real return in this past period was negative given CPI was so high so investors need to re-set their expectations for a while until we can get to a period where stocks reflect the reality or CPI crashes. If it does however, the economy will NOT be in a great place so be careful what you wish for. I’m sorry for the news but I have to report what I see. Only time will tell. The second chart below visually shows how wild and volatile that period was. To be sure, these days, markets move much quicker because of algo’s so the sea-sickness could be even worse in shorter periods of time, but it also can offer wonderful rallies like we have seen over the last month. Just don’t get too complacent because the trending markets of old are likely gone for a while longer.

How do you invest for a period like this? You get much more active than you have ever been and you stay up in quality, strong balance sheets, and strong pricing power. You have to be a superior operator in these periods and you have to sell products and services that consumers and businesses NEED or HAVE TO HAVE or ARE WILLING TO PAY UP FOR as I’ve said above. Problem: most investors, particularly advisor-driven ones are NOT active at all and they are over-diversified. In periods like this, your portfolio is destined to underwhelm unless you add some funds that get more active and are focused on the characteristics above.

Clearly theres alot of room for a major squeeze as short positions continue to build, all we need is a catalyst. It’s odd though, I also saw a chart saying this recent rally ranked very high on goldman sachs list of hedge fund covering shorts reports. How can hedge funds be covering while at the same time epic shorts being layered on?

Great summary of today’s CPI report from @callieabost

August 8 Market Notes

Interesting Monday in the summer. Pre-market NVDA pre-announced a revenue shortfall, blamed it mostly on gaming but reminded investors that are still generating string FCF and buying back stock. The stock is down about 8% but markets were firmly green for the first few hours, felt like shorts were getting squeezed and a very late sign that the rally is running on fumes. Perhaps Wednesday a CPI report that shows inflation coming down will add some fuel to the fire but I simply do NOT see much more upside near term. However, with positioning in equities still quite low and a potential for the “peak inflation and lower on ROC basis), animal spirits could get some more momentum to the upside. 4170 - 4200 is where we peaked today before rolling over as this is an area with big congestion and overhead resistance. With markets overbought after an impressive rally, I’ve been raising some cash and will continue to do so on further rallies.

Why raise some cash? 1)even if inflation slows and rolls over, it will stay elevated for much longer than people think. Companies are still implementing price increases even after their input prices have rolled over somewhat. While that offers a margin tailwind in future quarters, it also offers a potential revenue miss problem as demand cools from higher prices. I simply do not see how markets can get sustainable rallies with inflation stubbornly 2-3x where the Fed wants it to be. It won’t be long until people focus on stubbornly high inflation for longer versus the peak ROC of inflation. If inflation averages 4-6% for the next 12-24 months, estimates are likely too high and valuations are also too high for all but the most in-demand brands with the strongest of balance sheets and pricing power. The most relevant brands are very right-sized for this environment given their moats but I would say it is not the most ideal operating environment. Only when stocks really re-set for this reality will a buy and hold mentality be rewarded.

Thats why Im raising cash on every rallies. I’m about 10-11% cash now and I suspect its going higher.

Healthcare COULD be a good place to invest as profit outlooks are more stable and estimates seem more achievable. They have decent dividends too. Biotech is also quite cheap but that’s a difficult sector to analyze unless you have a ton of medical exposure.

The chart below is a bit of a north star for me. This is from Blackstone recent macro deck. It highlights what an appropriate multiple might be using certain assumptions on where interest rates and overall earnings could be. I’m struggling right now to see a world where the market should trade at 18-20x when estimates are still too high and inflation will eat into corporate profits in coming quarters.

July 15 Market Notes

Whether or not this is smart, we know with certainty the skew is “hold a lot of cash, be very defensive in your positioning, and have short hedges or outright short exposure. That short exposure is now quite extreme so wicked bear rallies can and will be expected without warning.

Great chart from Qualtrics highlighting where corporations will likely spend and cut costs. Bottom line: most who can, will invest in their growth and innovation right through a slowdown. They will cut costs by rationalizing employees and headcount, pivoting to more virtual conversations versus travel, etc. That’s why I like adding to tech, innovation and the enablers of corporate tech spend on every dang dip now that they have been significantly re-rated.

Good news, bad news: Bad news is consumer, CEO and small business optimism is in the toilet, the good news is, any data points that are LESS BAD gets these historic readings to also get less bad. This can drive a lot of good news for stocks given how extreme the bearishness is.

These are very unique times indeed. For perspective, here’s 200 years of calendar returns for markets and how frequent different return baskets tend to happen. With the worst start in 52 years and since 1970, we are in a thin air category currently.

July 1 Market Note

I think this says it all don’t you? Max bearish for the 3rd consecutive week. Well done Federal Reserve & politicians.

Worst 1H in markets since 1970 with the S&P -20%+ and the Nasdaq growth stocks faring much worse as rates rise, credit spreads widen, economic data gets softer, consumer data shows increasing stress with high food and energy costs. And the Fed keeps pushing on growth in a game called “Project Break-Shit”. I was curious to see what the next 6 months looked like after 1H 1970 and oddly back then, markets basically were at the bottom with a 27% up-move the rest of 1970. Things are obviously different now but I was pleasantly surprised. Heres what the forward 12 months looked like starting 6/30/1970. Lets hope we get some positive news to warrant something like this for the forward 12 months. God knows bearishness is extreme, positioning at hedge funds and systematic funds is extreme and traditional money managers is a bit extreme so there’s a metric ton of money that COULD come back in a very big hurry. From 6/30/1970 to 6/30/71, the S&P was higher by 37%.

Week of May 16 Market Notes

This market continues to feel on the edge of a bigger rally or a deeper pullback. Uncertainty is driving this view. There’s been massive damage to the average stock and de-risking has been deep and extreme. Exposure to cash is high among the institutional managers survey, they are now underweight tech to an extreme degree and rates seem to have stalled over the last week. The trajectory of rates is a key driver of tech sell-offs so this is a welcomed development. It’s clear the economy is down-shifting which should keep a lid on rates and keep inflation ex-energy and food from rising much further. The issue is the lingering food and energy inflation. The home improvement theme is still holding up well even though the stocks are volatile and expected to fall further as consumers further cut spending on discretionary items. I still expect the housing market will stay stronger than people think. Here’s some charts. to take notice of, some bullish, some bearish.

Bearishness got to 30 in 2018. In 2014, it went to 10 and 2015/16 it was at a low of 15. 2008/2009 financial crisis was ZERO. Today on Thursday May 19 its 19.5, not far away from the 2020 Covid bottom low.

Hedgeye Quarterly GDP and Quad framework indicates Q2 (now) but likely reported earnings in July could be the trough for the earnings slowdown. Doesn’t mean the economy will rip higher but could mean the rest of the year could get slightly better. ROC matters so getting less bad is a good thing. Then we get to see where the Fed is.

Week of May 9 Market Notes

Friday, May 13

Well, when the rubber band gets hella stretched, it can snap back viscously for a few sessions at least.

Carvana now $38.97

Peloton 15.4

Redfin 11.3

AirbnB 122

You get the picture. Its the names that got crushed the most that are largely snapping back the hardest but very few imo are well positioned for the economy we have currently. I love ABNB, just dont like the valuation but the trends of home sharing are clearly in their favor.

Tuesday May 10: the carnage in “emerging growth” is nothing short of 2000-like. Peak to today returns:

• Carvana -90% 376 8/11/21 to $36.6 today

• Peloton -93% to $12.1

• Redfin -91% to $9.72

• AirBnb -46% to 114.9

• Teledoc -91% to $28.7

• Wayfair -84% to $58.5

• Draftkings -86% to $10.7 showing positive divergences

• Fiverr -88% to $40.4 showing positive divergences

• Se Limited -83% to $64.6

• Roku -83% to $81.1

• Zillow -83% to $35.5 showing positive divergences

• Zoom -85% to $88 showing positive divergences

• PYPL -75% to $77.2 showing positive divergences

• Coinbase -82% to $74.9

• Upstart -92% to 31.1

• Shopify -81% to 326.8

• Thredup -84% to 5.4

• Twilio -79% to 95.4

• NextDoor -82% to 3.2

• Netflix -75% to 174.6

• Docusign -78% to 67.6

• Pinterest -78% to 19.9

• Square (Block) -72% to 82

• Sofi -83% to 4.87

• Roblox -84% to 22.6

• Lyft -73% to 18.4

• Uber -64% to 22.9

• Alibaba -74% to 84 showing positive divergences

• Affirm -90% to 17.1

• Spotify -75% to 95.5

• RH Restoration Hardware -62% to 282.2

• Snap -73% to 22.5

• Match -63% to 68.7

• Mercado Libre -61% to 781.1

• Shake Shack -67% to 46.7

• Etsy -73% to 83.8

• Unity Software -78% to 45.6

• Rivian -88% from ipo to 21.4

• Trade Desk -64% to 41.2

• Robinhood -89% to 8.9

There’s been a ton of carnage of -30 to -50% in mega cap, highly profitable stocks like Adobe (-45%) etc.

Well, the boat is certainly crowded with “inflation is here to stay and sell anything with growth attached to it. While individuals rarely have much commodity exposure, institutions generally do. And they are now as overweight as they have ever been. The second chart is really what intrigues me: it shows how stocks react to an initial CPI decline after having CPI exceed 8%+. Obviously, any sign that inflation is not getting worse and in fact could be easing will be greeted with a very strong upside response, at least historically. Then we have to worry if the Fed will use that data to be less aggressive. I suspect they will be stingy to make sure any easing is NOT transitory. But we are certainly oversold enough to get a fierce 1-3 day rally where sellers will be back.

Actual 1Q22 reported buybacks amount to $250 billion (for 86% of S&P having reported); already sets new 12m record of $953 billion, surpassing prior record of $882 billion, set in 4Q21 (that is without remaining unreported 14% for Q1 2022). The buyback window for buying is in full view today. It could offer a temporary respite from the buyer-strike we have now. And these are big buyers as the graph shows.

I know passive observers of markets think the market has largely gone nothing but up the last 3 years but as you can see from the below image, we have had 3 crashes in 3 years, this is NOT normal folks. We’ve also had multiple vol spasms along the way. This is NOT an easy game, the last 3 years have been a very wild ride.

Very interesting post yesterday from a man I really respect. BTW, he is rarely bullish and always cautious.

It’s a good time to remind ourselves of Bob Ferrell’s 10 Rules of Investing

If we get inflation under control and stabilize the economy, theres lots of value in prices today

Week of May 2 Market Notes

2021 & 2022 Delinquincies remain low and not inflecting higher as they did in late 2006/early 2007 - below. This will be a hint about inflation creating consumer issues

Delinquencies inflected higher end of 2006, early 2007 and began to go vertical even as stock markets remained elevated. Delinquencies inflecting though, is a great leading indicator to trouble to come. For now, we have NOT seen anything of note.

For those linking today with 2000, the 65% of the stocks driving QQQ today are very different than those driving 2000, much higher quality, and a much more tech-focused economy with valuations in the quality basket much more attractive than even consumer staples. Narratives aren’t FACTS

Quick note from JP Morgan Trading desk - retail needs to stop buying the damn dips before the real bottom comes but my gosh are there some attractive prices in great brands. Maybe it gets even cheaper and better but there’s some real strong gains over the next few years being offered for those with pat

Week of April 25 Market Notes

1. Monday: Twitter, without other real options, accepts Musks bid to take the company private!

Week of April 18 Market Notes

Monday, April 18

From Rich Bernstein: This morning’s LEADING #Indicators declined a bit but show absolutely no sign of an imminent economic #recession.

Unless your base case is rates can only go up for the next year+ and inflation is not going down at all and will keep going higher, the growth stock complex, particularly the most profitable growth brands, are back to be highly attractive relative to the value stocks. The minute the world sniffs out a peak and/or slowing growth, growth stocks will catch a bid unlike we have seen in a very long time given how under-exposed to these names the world is now. Remember, hedge funds have rarely ever been this under-weight tech.

The big growers relative P/S are now at levels where bottoms have occurred. Again, maybe its different this time and rates and inflation will drive them to get absolutely cheap, its time to start building bigger positions in growth.

@ukarlewitz on Twitter with good post today: Conference Board Leading Economic Indicator (LEI) on the rise through March. It has historically peaked a min of 7 mo (avg of 11 mo) before the next recession

Truck tonnage in March the highest since the ATH in Aug 2019. Trucks carry 70% of US freight (from ATA)

Ed Yardeni with the Investors Intelligence Sentiment Report - timing uncertain but low readings like this arent generally bearish for forward equity performance - we just need some more clarity from Fed, Ukraine and QT

Just look at where we are via AAII Sentiment - Bull ratio very low, Bull/Bear Ratio on the floor at a rare -.3 reading. Clearly there are issues and some big ones can last but the stage is set for any positive developments to bring oodles of money back in whenever that occurs.

Not that we need a reminder that equity markets can be volatile and offer drawdowns, that’s just the nature of the beast, but here’s the reminder in a look-back.

Magazine headlines tend to mark the top or bottom in major trends. Will this age well or mark a close peak in inflationary pressures?

Week of April 11 Market Notes

Tuesday, April 12

The positioning among institutional investors remains skewed to the negative and heavily defensive. Yes, its been the right call YTD but at some point there is an unbelievable amount of money that will rotate out of the most crowded trades and back into things like highly profitable tech and high quality consumer stocks. Until then, we are in the chop-bucket.

Global growth optimism is at all-time lows folks - at levels from the GFC 2008/2009, pandemic lows. As you can see from December 2000, this pessimism doesn’t have to a contrarian buy signal, every time is different but my gosh it won’t take much positivity to drive meaningful money shifts.

A big component of CPI is auto’s and the prices are out of control but due to mean revert

Monday, April 11

Great notes from Michael Cembalast at JPM

• we expect the March 15 equity market lows to hold as long as there is no US recession.

• Some recession indicators are rising: first inverted 2-year to 30-year yield curve since 2007

• a collapse in consumer sentiment to one of the lowest levels in 70 years

• declining small business surveys

• ISM business survey orders falling below inventory levels for the first time since the expansion began

• China’s supply chain delays and spikes in anchored containerships due to COVID

• Labor markets are very tight (there has never been a recession without a large spike in jobless claims)

• household and corporate balance sheets are in very good shape

• US recession risks look higher for 2023-2024

• 2001-2002 selloff - the median NASDAQ stock was down 75% from its peak vs the feb 28 lows 2022, median stock down 40% from peak

Another day, another sell-off in equity AND bond markets.

HY bonds now 6.5% versus the 4% at the start of the year. Yields on bonds are finally getting more interesting but my gosh with the expected VOL on rates and the bond math, the returns still don’t seem very attractive versus stocks.

The uncertainty we have now should keep markets from levitating much but by the middle of the year we should see stocks stabilize. What’s the strategy from here to then? Buy the highest quality, strong profit and cash flow businesses on the dips the markets offer. That will be a great long-term strategy even if it feels bad today. From a rates perspective, here’s the 40+ year bond bull market, yields are hitting the 40 year downtrend now. We can certainly go higher in yields but there’s a whole other group of issues that arrive if rates go much higher and with the trajectory they are doing it in.

A very clear example. ofthe concept that just a handful of stocks tend to drive the bulk of the index returns. Here’s 2017 to 2022, top 4 mega-cap growth stocks performance versus the growth indexes

For those that still can’t figure out why certain stocks are lagging for now: it’s the trajectory of rising rates that matters most.

Look at the Feds balance sheet, my lord it’s bloated. The real question: who are the early buyers of all the debt the fed wants to sell starting in May?

This is quite the software valuation re-set.

Hedge Funds have been in de-risk mode all year. Remember, these are the players that use massive leverage on occasion and get over their ski’s at the wrong time very often. Well, today they are the least exposed to Tech as they tend to get. Below is other time periods when HF were this negative on tech via low exposures. Most important, it’s only a matter of WHEN they get back into tech and now, there’s plenty of new buyers when the CPI numbers likely have peaked. I don’t know when but the crowded trades of rising rates and inflation beneficiaries will suffer rotations and tech will be the first place they rotate into.

In case you can’t see the returns, here’s the story: When HF have gotten this negative and under-exposed to Tech in the past, the forward 6 month returns have been quite positive. Max drawdowns look like ~2% and anywhere between 13% and 24% were the prize.

Great summary here from Twitter: @aboutheoptions. All people want to say is: don’t fight the fed and the fed is now NOT your friend. Until they pivot if/when CPI clearly peaks

Lots of chatter is happening comparing todays environment with 1994. There are some similarities and differences but below is what 1994 looked like and when we saw fed rate hikes and what markets did during and after those hikes. I have said for a while that 2022 is a throw away year, it will be highly volatile and largely frustrate most traders and investors and then once we get through some of the tightening and rate hikes with CPI falling back to more acceptable levels, the equity markets will take off again. In the meantime, just keep nibbling on your favorite profit compounders on the dips the market offers.

Here’s the part of inflation that will be sticky for longer: wage pressure in a tight labor market. You better have some pricing power and be able to wring out some internal costs to keep your operating metrics from collapsing.

Low wage compensation is rising faster than middle and high wage workers, thats great because the lower wage cohort is the one hurting the most and these folks have less wiggle room each month.

The following chart shows where each income cohort tends to spend their money. Services continue to be the biggest spend and durables being the lowest spend.

Week of April 4 Market Notes

Tuesday, April 5

THIS WARRANTS CAPS: YTD WHICH STYLE FACTOR CHARACTERISTICS HAVE LAGGED AND OUTPERFORMED MOST?

THE WORST PERFORMERS…WAIT FOR IT: THE HIGHEST PROFITABILITY & HIGHEST QUALITY BALANCE SHEETS.

-12% YTD for the high profitability basket

-8% for the strong balance sheet basket

+15% high dividend yield stocks, aka defensives and income for rising rates

You can chase low quality, highly levered balance sheets into a slowdown but I’ll keep adding to the highest profitability, strong FCF growers with great balance sheets, they win in the end. It’s not disputable folks.

Next point:

Key: “On average, stocks performed worse 1 year before a recession than during the recession. In the 2 years after a recession, price returns were positive 82% of the time.

Monday, April 4

There’s been a clear pivot in the growth versus value underperformance in favor of a return to growth stocks. Valuations have been broadly re-set and most growth stocks have had significant pullbacks. For many, the secular growth opportunities have not changed and are intact yet the stocks have become much more compelling. I’m not surprised to see some of the biggest laggards having strong rallies because they were so beaten down. Whether these are bear market rallies or the beginning of a lasting recovery depends on the stock but the end of growth stocks does seem greatly overblown. Many. ofthe most beaten down growth stock, lets call them the Ark stocks with no profits, cash flow or earnings, may never return to their former highs but the stable predictable growers with real profits and cash flows should return to old highs and then some. That’s certainly where I’m focused.

Here’s a great chart showing valuations across the globe for perspective. Valuations are rarely a catalyst but it’s very clear: the US is the most expensive but does have the highest quality assets and growth stocks. Japan and Europe are the cheapest regions in the world but generally I wouldn’t say thats where innovation lives.

Just another reminder that inflation is pulling consumer sentiment down to levels that are generally very bullish for future consumption growth and better stock price action.

This chart is very important and one to keep monitoring. Here’s the Federal Reserves reporting of 90+ day delinquencies across: mortgages, revolving credit lines, auto loans, credit cards and student loans. Bottom line: theres no evidence of worrisome signs that consumers are starting to be late on their payment obligations. This is one key warning sign of inflationary pressures and recessions.

Week of March 28 Market Notes

The following charts are a great look at real personal consumption expenditures and highlight how above and below trend we are from a goods versus services perspective. Lots of things have changed since the beginning of Covid, some brands and spending categories have stepped up into a new demand level and many are just beginning the mean reversion process. The market has clearly been front-running this process, most of the goods retail businesses have already corrected 30%+ and/or have returned back to the pre-pandemic price levels. There is bound to be a few quarters to even a year of re-setting long-term trends and correcting of stock prices before normalization arrives again. Services still seem to have a fair amount to go, particularly in some pent up demand areas like travel, cross-border travel , lodging, recreation, etc. Charts are from Goldman Sachs. Chart 1=we are back to the long-term PCE trend but within that trend theres a wild number of over and under-earning by company.

Inflation is the talk of the town and it’s everywhere. As a guy who studies consumer behavior, I am well aware of what drives people to change habits. As we get squeezed from every direction, we begin to mentally categorize every purchase into 3 baskets: 1)I need that item, 2) I really want that item and 3) I have to defer the purchase of that item. As an investor in consumer trends, my investment choices are tied to these consumer questions with inflation so high. To be clear, my belief is that companies that are raising prices will hold those prices until they see a shift in demand and then they will be forced to lower prices to stimulate demand again. That’s the decision MOST brands will have to make soon enough. That decision will have implications on margins and revenues and brand loyalty. At the higher end of the spectrum, those price discounts will be slower or non-existent unless the company see’s a significant set-back in demand. Pricing power with zero erosion in demand is where you want to be right now. Also, you want to be in the brands that will thrive as consumers “trade-down” to try and save money. A luxury, high pricing power with strong demand plus price discounter barbell is where we are focused today with stock selection. Here’s a great chart showing the growth of wages versus the growth of expenses in today’s high inflation. What it shows is, the lower the income cohort, the more expenses are overwhelming these consumers and forcing them to make tough choices on their spending. While I have seen some consumer sentiment data that talks about high income consumers and their interest in deferring purchases, we still haven’t seen much evidence yet. Remember, if you have the extra money, you may moan and groan more but you will likely still purchase what you want to purchase. If there’s a negative change in income though, all bets are off.

Great chart showing the semiconductor industry and players that dominate it from @investquotes on twitter. Currently, the brands portfolio owns ASML, NVDA, AMD, AAPL, TSLA

Week of March 21 Market Notes

Friday, March 25

Consumer confidence continues to fall to historic low levels due to high inflation for needs and wants. While that portends slower GDP and consumption for Q2 (market already front running that via its weakness), it also leaves massive room for improvement if/when inflation peaks and more certainty arrives in markets. To me, thats the real opportunity. Often the biggest gains come from periods of horrific to less horrific. Here’s a chart of buying conditions for homes, vehicles and bigger ticket durable items.

Perspective: Long-term markets often go from sideways, boom/bust to bull market trend. Here’s the look today. A solid case can be made for a new bull market trend that began in 2013 when markets broke out of the huge sideways range from 2000-2013. If typical bull trends last ~15 years, we have plenty of room to run. Covid and all the crazy distortions that were created out of it, have created a lot of noise but the bull trend does not appear to be completed.

Great chart from Michael Cembalast at JPM showing what the avg stock, index and median stock has done as of March 8 across all the indexes. Result - the average stock in the Russell 2000, Russell 3000, Russell 1000, Nasdaq 100, Nasdaq Index is already in a bear market. The damage has been so much more severe than the S&P 500 indicates.

This is an even better chart showing the average decline from prior peak across the indexes when compared to a recession typical decline. Bottom line: IF no recession occurs, the drawdowns we have already seen are right in-line with typical drawdowns that happen. They never feel good but they are a normal part of the long term investing landscape. Clearly, rates, inflation, fed uncertainty have created a potent cocktail of adverse risk taking but we are well within the “normal” band of corrections. The valuations and prices got very very extended from reality and we have and are wiping away those extremes now.

Heres a quick reference guide to the assets and drawdowns since the S&P 500 peaked. It’s been a crazy time folks.

With a week like last week, there’s very little that could excite me given the high bar but I think we just have lots of chop for the next few months. Earnings will start again in 3 weeks and any company with international exposure will likely add a note of caution given whats happening in Europe and what could happen in Asia. Ah, 2022 is shaping up to be a tough, volatile year.

What do we do when things are volatile? We trade more. I’m now only looking for trades that are 1-5 days, I want to see the VIX stabilize but with a strong week last week, the VIX is now back to the low end of the range at 23 so a better time to sell trades.

Barrons never fails to be a great contrarian indicator but with issues in Ukraine and Russia, things could get bad in agriculture land real quick. I sinscerely hope our politicians understand.

SAAS MULTIPLES GOT WAY OUT OF WHACK, THEY ARE MEAN REVERTING AND THERES SOME OPPORTUNITIES NOW. THE MOST EXPENSIVE GROWTH COHORT IS BACK TO “NORMAL EXPENSIVE CONDITIONS, THE MID GROWTH MEDIAN ALSO BACK TO NORMAL BUT THE LOW GROWTH COHORT IS NOW ABSOLUTE CHEAP. For me though, I’d most likely be looking for brands in the blue and red area.

Here’s the breakdown of the universe when compared to the growth expectations and the current multiple. Some observations: VEEV, MDB,NOW,ADSK,ADBE, WDAY, U, SNOW, CRW, SHOP, DOCU, are still slightly more expensive than the mean avg of the growth cohort even when taking into consideration of the growth opportunities. Then you have to do the work on which company is worth paying a premium. But the best result is, the massive overvaluation that we saw has largely been rectified and it seems very smart to start picking through the rubble.

On a more positive note, corporate America has a massive cash hoard currently, particularly a handful of the biggest companies, aka brands. Look at Google in particular, my lord. FB, Meta also has a hoard of cash but they intend to be spending a ton of cash on the next-gen Meta platform, I’m still skeptical of their ultimate ability to monetize whatever the Metaverse becomes but there’s probably not a ton of downside in the stock with the balance sheet looking this strong. 9% of Googles market cap is cash, 8% of Meta’s is cash, Apple and Microsoft at 3% and 2% of Amazons in cash.

Unless you think this period is most like 2000 and 1973, many people do, I absolutely do NOT, buying Nasdaq stocks AFTER the 20% drawdown was most often a wonderful decision assuming you have more than a nanosecond time frame. Why don’t I think this is like 2000? Make no mistake today’s period rhymes like 2000 with all the garbage SPAC’s, hundreds of IPO’s of companies that don’t seem to have any path to profitability BUT the blue chip tech brands at the top of the index are wildly more profitable, unbelievably more dominant and at the center of tech innovation that will not, can not stop unless china and Russia hold back all the minerals that go into tech. And inflation was all the rage in the early 70’s and now, inflation is all the rage. Wait, now I’m scared lol.

I believe the services sector, particularly leisure travel has a lot more room to expand. Here’s a great chart showing when the services % of PCE fell below trend, there was a wicked, multi-year period when it mean reverted and got back over trend. I’ll add more services and particularly travel on dips. The second chart shows how the inbound/outbound travel spend is still well below where it normally is.

Week of March 14 Market Notes

Friday, March 18

Well the Nasdaq was up 10% for the week and SPY +6%-ish, hows that for a bear market rally? These daily moves wreak of high uncertainty and zero confidence. This remains a problem short term but a wicked opportunity long-term, as uncertainty always reverts to more certainty and the market likes certainty.

Wednesday, March 16 - It’s FED day, isn’t it funny how they say every fed meeting is THE most important Fed meeting EVER? Well, this meeting is kinda important but I don’t think anything will change:

The fed will hike by 25bps - expected

The fed will talk tough on inflation - expected but at some point the market will realize they have ZERO aircover to hike 5-7 times

The fed will remind people again, they are data dependent and there’s alot of issues and concern out there which are already leading to economic softness. This will matter when it matters, I’m not smart enough to know when that is.

I don’t love the market ripping yesterday and today into the meeting though, raises the chances of a sell the news knee-jerk response but with so much positioning in both directions, Im confident there will be quick, sharp moves in both directions. It will take a day I suspect to see how the market really feels about the trajectory. More certainty is better than what we have now but I suspect the Fed wants to keep animal spirits at bay for now so they will be balanced in their comments.

More on the decision and comments after they occur.

Some great charts: There is a very predictable inverse correlation between consumer sentiment and rising inflation. With the price of everything going up STILL, consumers have likely already begun to make the this versus that decisions and lower income consumers are likely trying to defer where they can and cut costs where they can. We will see that in April earnings reports. The trick is how much of that eventuality is already priced into prices as they have come down an awful lot. I guess it depends on how cool or hot we go into earnings and what the world looks like in a month.

This chart highlights one of the many reasons I like Blackstone BX as a top holding: they have been invested in some of the best neighborhoods with regard to themes for many years. Rise of e-commerce via more warehouse and logistics space, life sciences growth, and housing via rental real estate. The hard asset of housing and real estate has historically been a stable inflation hedge and the rents and their ability to rise provide much better income than traditional fixed income. Whether renters like it or not, Asking rent growth is strong. If you have the means, you buy a house or condo, if you don’t, you have to rent. I simply do not see an end to the stability of the housing market anytime soon.

The next chart just shows where a potential pain point could be if things slow further and the fed pushes on the aggressive rate hikes and QT. There’s a significant amount of leveraged loans in the market, it doesn’t take much softness to put some pressure on repayments. HY defaults are very low right now but something to watch. This is yet another reason I do not believe the Fed can do what they say they would like to do to fight inflation, there’s simply too much leverage in the system for them to get too aggressive like Paul Volker did decades ago. The economic damage would be horrendous.

Inventories are building everywhere - great post from @gavinSbaker

Tuesday March 15 - A chart storm!

The wall of worry is large - as we pick away at these 1x1, uncertainty will turn to more certainty and that’s great for markets. Next chart shows what risks are most prevalent currently.

Great stats on corrections, bear markets, time, etc.

Supply chains are NOT fixed. Why? Because China does not want them fixed. Policy makers over-reacting to Covid are not doing what they need to do to fix them either.

Nobody wants tech stocks thats for sure, my gosh they are fickle, Tech is only the best performing sector for 3,5,10,15,20,30 years. Maybe tech just needs to cool off a bit? If you want growth and stability of balance sheets, mega cap growth is the place and they are on mega sale right now! They can hate tech for longer and get more underweight like towards the bottom in 2003 but that’s an extreme case and if we see that I think I’ll have to be 100% tech!

This will put a dent in your dinner plans when you spend dinner putting gas in your car to go to dinner! Get an EV please, I spent 2/3 less on my car across service, no gas versus a charge, and general maintenance.

When nobody expects something, does it happen? Generally. So nobody expects a good economy?? I mean these are back to 2008 and 2000 levels for heavens sake.

Everybody citing they aren’t taking much risk relative to “normal”. That’s obvious when we see daily volatility - there’s clearly a buy strike for now.

Empire Manufacturing General Business Conditions - Attention Federal Reserve, the data is clearly weakening, will you be aggressively hiking into it? NOT a good idea

Hedge fund exposure also quite low. I don’t know when but my god at some point the amount of cash that’s going to get put to work will be epic.

60% of market participants surveyed expect a bear market. Well, the Nasdaq is already in a bear so DAH

Weightings to cash are quite high. Cash in money markets also epic at $4.5 trillion! Consumers still have >$2.5 trillion in savings accounts as well. One day some of that money gets put to work. When we have some catalysts, sweet Jesus the rally will be robust.

Here’s a disconnect, fund managers are not bullish on global growth yet they havent de-risked as much as they typically do when they are this bearish. Second chart also shows how bearish folks are currently. Maybe they are hedging with put?

Inflation and stagflation is now the most believed narrative, any change will require much different positioning.

Nobody believes a steeper yield curve is in the cards at this point. What a few months make!

Current positioning clearly towards defensives and commodities and away from European equities and discretionary stocks. In my experience, betting against the consumer has largely been a bad bet,, particularly when their overall balance sheets have been so strong.

Monday March 14

Groundhog day for growth stocks, still getting pounded, regardless of business fundamentals. This too shall pass, It’s always painful to watch but the opportunist in me loves getting better prices for great businesses. I continue to build the next 12 month portfolio into this absurd weakness. Full buy strike and uncertainty everywhere. IN HK, china stocks are getting destroyed, I don’t think the chinese consumer is loving Xi, even if they can’t say it out loud for fear of their lives. Lockdowns in tech hub, Shenzhen, now so supply chains will get messy again and the production of tech supplies will grind to a halt.

Make no mistake - China has a vested interest, just like Russia, to keep the heat on the West, keep inflation high, and economic prosperity in question. This is an economic war folks.

Not that I believe chinese data but the data today is actually pretty solid, even if its rolled over since.

Private equity stocks are like 2x levered high beta stocks when the economy is slowing or accelerating. Right now, these stocks, BX and KKR are holdings, are getting clocked due to high inflation, higher rates and slowing economic growth, but these firms have raised so much money in the last 3 years and have so much dry powder to put to work in tumultuous times, they get me very excited as they come down. They are cheap, have great dividends and/or great dividend growth, are always buying back their own stock, heavily owned by insiders, and are superior capital allocators. Here’s a few charts to remind people of the biz trends vs their stocks, which can be volatile in wild markets. An estimated $3 TRILLION in capital is ready for deployment at the right time and in the right places. Once this happens, the fee revenue machines get a new boost and these stocks all beat estimates and they go higher.

Sunday March 13

Lots of ugly newsflow over the weekend. More bombing in Ukraine, China locking down because of 1-3,000 covid cases, lol, mind you China has like 1.2B people. These lockdowns are not about protecting citizens, they are about keeping inflation high and shutting down supply chains on a periodic basis. IMO China is already at war with America and maybe the west and likely working behind the scenes with Russia. These two countries want everyone around the world to bend a knee as they control more of the worlds resources.

REMEMBER THIS: IF THE WORLD IS FOCUSED ON CLIMATE CHANGE AND A MORE SUSTAINABLE EXISTENCE, THOSE THAT SELL AND CONTROL THE LEGACY RESOURCES HAVE A VESTED INTEREST IN KEEPING VOLATILITY AND PRICES HIGH SO THEY CAN MILK THIS COW FOR AS LONG AS POSSIBLE. THE BRIDGE FROM HERE TO A MORE SUSTAINABLE WORLD WILL BE ROCKY AND VOLATILE SO JUST ACCEPT IT AND TRY TO MANAGE THROUGH THE VOL.

Turning to market breadth, here’s an observation:

At the close on the last market low of 2/24, there were washout readings when I look at breadth stats.

On 2/24, just 6% of the S&P 500 and 15% of the nasdaq stocks were trading over their 10 day moving averages. JUst 17% of the nasdaq names were trading over their 150 day moving average. 29% of the S&P 500 was trading over the 150DMA.

At fridays close on 3/10, 26% of the S&P 500 was trading over the 10 day and 33% of the index names were trading over the 150DMA. So 33>29 - close to each other but slightly less bad while the SPY closed lower than the close on the 24th. The index closing low was lowest on 3/8 vs 2/24 and short-term washout breadth was still much worse on the 24th closing low. The 150DMA data was basically the same. The same is true of the Nasdaq.

What’s this mean? Its just data in the end but it says that for now, we are still seeing some positive divergences between the individual stocks making new lows and the indexes finalizing their capitulation, washout process. As in 2008/2009, this current period could be like the late fall of 2008, we have a washout low, wicked rally, then had a final horrendous plunge into March 2009. I do not know the future but this market seems to be holding until it gets the data and trajectory from the Fed this week on the 16th. Then it can make its next move.

With all the geopolitical issues, and likely earnings rolling over, I would be absolutely shocked to see the Fed being as aggressive as the world believes they will be. There is simply no reason to be aggressive on rate hikes and QT in this environment, they missed their window, now they will need to sit tight, move very slow and give the market that certainty.

Week of March 7 Market Notes

Consumer sentiment, not shockingly continues to fall due to high inflation and prices of gas in particular.

The year-ahead expected inflation rate rose to its highest level since 1981, and expected gas prices posted their largest monthly upward surge in decades. Personal finances were expected to worsen in the year ahead by the largest proportion since the surveys started in the mid-1940s. Consumers held very negative prospects for the economy, with the sole exception of the job market.

Here’s the thing though: Humans have recency bias, when they have great experiences, they tend to think they will last forever, when they are very concerned, most of the time, the hurricane is almost over. The current inflation issue is NOT going away anytime soon, however but this is the first time I can find when corporate and household balance sheets were healthy during this kind of economic issue. It doesn’t mean there won’t be pockets of issues, there will be, particularly at the lower end of the income spectrum. The average tax refund coming this year is $3500 per Morgan Stanley, thats higher than normal, this could give the lower income cohort a bit of breathing room at a time when they need it most. Because of higher gas prices, the average household has an extra $1600 a year energy burden, consumers are resilient, when they need to tighten their belts, they begin to change behavior: only buy gas at Costco, the cheapest place in town, shop more at Trader Joe’s, much cheaper than other markets, don’t go out to eat as much, defer that discretionary spending this month, take a different, experience based vacation, spend more time in nature etc.

Bottom line: we should expect consumer sentiment and spending to stay volatile, but historically, when the data is as low as it is currently, sentiment reversed higher and stocks had pretty robust forward 12 month returns. We are lapping unprecedented stimulus and policy accommodation as well as very strong corporate earnings, things need to normalize which is why the stock market has already pulled back. Over 75% of the Nasdaq stocks have already fallen 25%+, the correction to this stimulus is well under way. We just need to get through the next few months of wild swings and earnings resets. The highest quality companies are in the best possible situation to ride these storms out and they have oodles of cash and are aggressively buying back stock when they get beat up, over time, those will be accretive buybacks and be shown to be strong capital allocation decisions.

A great look here on the tiger cubs hedge funds and the hyper growth stock ownership. There’s certainly been a ton of pain in the most speculative names and most are off 60%+, by the end of this could be 80%, some are already there. Picking through the rubble will be fun.

Monday March 7

Not a pleasant day in markets with idiotic moves down in some travel and private equity favorites. Good news: for now the close showed many more stocks trading above the 10,20,50 day moving averages than the last time we were around the Feb 24 levels. Other than the intraday low on the 24th, the indexes are lower but the number of stocks trading above these moving averages was higher. That’s a positive divergence which tends to mean the markets and rubber band is stretched too far and we could be due for an oversold bounce.

Tuesday March 8

Well the wild volatility continues. My buddy Sean at Avory & Company sent a great post that everyone needs to be reminded of during these times. High VIX means there’s a ton of uncertainty and it also means the daily trading ranges should be expected to be wide=great trading environment versus buy, hold investing. Maybe a strategy that buys and holds great brands PLUS trades around these brands in periods of high VOL can add value over time? I think it does.

Here’s a longer term look at cautious periods when VIX is elevated. My rule is >20 hereto stay for a while? Take trades when you have good set-ups. >30 get more cautious but look for washout signals which happen closer to 40 and above. Then there’s always the pandemic and 2008/2009 crisis when VIX can get >80, very rare and painful but offer wildly bullish opportunities in major capitulation. That capitulation typically happens when we see <5% of stocks trading over the 10,20,50 day MA.

I know people hate tech now, valuations were absurd and rates and low inflation were a great tailwind but the secular drivers of innovation have never been stronger and looking at the chart below, SAAS valuations have collapsed back to “normal range”. Just remember, there’s a ton of recurring revenue and stability in the businesses of the best tech companies so don’t expect the greatest companies to be outright cheap alot. Relative valuations also matter.

Wednesday, March 8

Bear markets, bear rallies, VOL, and uncertainty

We have already established that there is about as much uncertainty as I can remember having for many decades. The economy, Russia/Ukraine, interest rates, inflation, stagflation, the Fed and its QT trajectory, consumer spending, supply chains, shipping lane congestion, input cost inflation, commodity inflation and scarcity, etc. All of this uncertainty will keep the VIX higher than normal which simply means each day investors/traders HAVE to expect wider swings between peak and trough levels. That makes “investors” sea-sick, it makes traders giddy. If you are willing and capable of active trading around the core, you have the potential to add short-term gains that can build up over time and add to the short term unrealized losses you have on your core, long-term holdings. In time, the uncertainty will be replaced with less uncertainty and eventually some actual certainty and the market loves certainty, even if its bad certainty versus having persistent uncertainty. When the uncertainty peaks, maybe its now, maybe its later, markets can begin the re-risking process. That’s what I am positioning for currently with the understanding that the timing is uncertain. All we can do is have a small group of companies that we have high degree of confidence in and be willing to build bigger positions in them as they come down so when the bottom comes, likely due to more certainty, your recovery is more robust because you’re in the right recovery stocks. Having said all that, here’s what bear markets and bear rallies look like. We never know if a bear rally is THE beginning of the recovery but for now, I suspect these bear rallies will be sold. With some luck we get some more certainty in Ukraine which could lead to more sustainable gains.

Friday, March 11

Well, I get the reasons but there will be massive massive opportunities in european stocks when/if the uncertainty is removed. There will be an epic amount of money incrementally moving back into european equities at some point. Think of the iconic brands trading there: Ferrari, LVMH, Hermes, Kering, Nestle, etc. Time to get my shopping list ready.

Visa spending index update:

It looks at YOY momentum, strong momentum in US spending volume but we should expect a decelerating trend when March data is reported. June 2020-Feb 2021 it had negative data. This data is so distorted with the stimulus payments so we should all expect unbelievably volatile data. March is a comp versus the bigger stimulus last year so it will look bad given the lack of stimulus now. I know analysts use ROC and comps but using this data seems worthless now as its not incredibly important when comping historic non-recurring payments. Let the data settle, then we get back to normalized numbers.

Week of February 28 Market Notes

Wednesday March 2

Well well well, AAII bearish sentiment rose to 53.7% - that’s at the 100%tile for 2 years and 97%tile for 20 years. YES, we can get more bearish given all the Russia/Ukraine news and collateral damage to economic growth and sentiment as well as the uncertainty from the Fed policy direction and timing but historically it was a pretty good time to begin sifting through the rubble in stocks to find some bargains. VOL will stay high which means trading opportunities in both directions should be solid but for long term investors, buying when the masses are bearish has been a pretty solid outcome.

I’ve said for a while now, the FED has zero shot at doing 5+ rate hikes let alone starting Quant tightening. With the economic data to begin cooling off a wicked strong base rate in Q2, potential geopolitical issues lingering for longer and inflation data cooling ever so gently, there’s a strong possibility some slight dovish pivots are coming our way. And when that happens, the world will realize they are much more bearishly positioned for an outcome thats less severe. These wicked rubber band moves can work in both ways and I suspect at some point in a few months, the upside opportunity with clarity could be quite robust. Thanks for the tweet Mike!

Week of February 22 Market Notes

Friday, February 25

Loathing of tech and “beta” is getting extreme…there will continue to be some wicked short covering rallies in QQQ names. WHY? Because they are being heavily shorted and many of the member in QQQ and XLK in particular are among the most impressive companies ever created. There will always be demand for industry leaders, strong profitability and mega sales when they collide. All we need is a match, the wood is ready.

Valuations were stretched across most asset classes, some are still stretched even after massive drawdowns, some are very attractive but overall, the argument that the market is too expensive is giving way to, “the market is more reasonably valued, particularly versus fixed income and real yields still under zero when you consider inflation”. I say again, NO WONDER BX, KKR, CG, TPF, and APOLLO are raising so much money, there’s hundreds of trillions in global fixed income that will generally earn nothing and be more volatile than it’s ever been. And I’ll say it again, with all that, why does everyone worry so much about equities? My gosh, I’d much rather own high quality equities with good growth characteristics and a basket of real assets than anything related to fixed income. Maybe I have lost my way.

There’s been a lot of chatter about the real estate market thats still red hot and it’s ultimate cooling because rates have headed higher and home affordability is now low. I think directionally that is an ok assessment except we need more data to really understand the complex real estate market. 1: wages are also rising and in most cases, wages and income have risen faster than mortgage rates that been pushing affordability down. 2: if you own a home and likely have nice appreciation embedded in the value and want to sell, you sell one appreciated asset, capture a good cash return and have the ability to roll all or part of that cash into a new home. Having the excess cash from the highly appreciated asset really takes the edge off the appreciated price of the new asset you are buying. 3: institutions are the primary driver of real estate purchases these days and they are buying for different reasons than individuals. Traditional fixed income, income + capital appreciation of the bond as rates fall, should offer a negative real return over time so large institutions are looking for non-traditional income and inflation protection via assets that can appreciate in inflationary times and generate attractive and predictable monthly income. Housing does that quite well typically and these institutions are not investing in real estate for a quick trade,, they are taking inventory off the market and it will stay off the market for years and years. That keeps inventories low and prices stable and rising. 4: demographics matter and the charts below from Alpine Macro highlight the demographics are quite favorable for the housing market as younger people begin the household formation process. I do believe the home market will require smaller footprints as younger people tend to get married later in life, have less kids and thus will require smaller homes. But the demand should be stable and growing and every pullback in rates should bring in pent up demand. Homes and the home improvement thematic is still a big one for the brands portfolio.

Thursday, February 24

As many of the charts and notes below show, bearishness is getting extreme and at least a wicked oversold bounce is likely at any time for any reason. BUT the biggest worry I have now is not really being talked about. It’s impossible to put a percent of odds on this outcome but China has a history of being ruthless so nothing would surprise me. Here’s my worry:

Russia is now invading Ukraine - why? Well lots of reasons but as always, resources that are vital to the USA and other world players is a likely motivation. The tech sector and growth depends on vital resources like Palladium, Neon, and C4F6 (thanks @convertbond). These resources are vital for semiconductors and lithography machines that make semiconductor manufacturing possible. Neon is found almost exclusively in Ukraine and Russia as are the other resources. So it is certainly possible that the sanctions placed upon Russia could force them to try and seize control of these resources in Ukraine and withhold them from the US and other countries. This could create quite a supply interruption and drive prices straight up while Russia benefits greatly. The same is true of oil.

Then enters China. We already know they believe Taiwan is still part of China and they want to bring the country back into the empire’s control. Taiwan is a key and vital country for semiconductor manufacturing and supply with TSM being the leading partner to all global semiconductor brands. So two very bad actors, Russia and China control a large part of the vital supply of resources that are crucial to have for tech growth in a tech focused world. That gives them way more leverage than a group of bad actors should ever have. Shame on every country for allowing bad actors to have so much leverage over the world. That’s what keeps me up the most at night.

For now, the markets are front running an earnings slowdown that has yet to materialize. BUT we know the April earnings will show some of that weakness. The question is: will the weakness be correlated to the horrific drawdowns we have already seen, particularly considering the Fed will have hiked in mid March and offered some more clarity in guidance at a time when we have so many geopolitical risks?

Good summary from Potomac Management, a OCIO and great technical analysis shop:

Breadth metrics have weakened across the board as equities have come under pressure this week. Advance/Decline data remains under pressure for all markets, and new lows remain elevated on the NYSE. Interestingly, short-term trend data is not yet at levels that we would classify as washed out. I’ll add, we are very close to those wash out levels but with sentiment this bad and geopolitical news happening fast, anything is possible in both directions. This would be a good time for China to make a move on Taiwan while the world is focused on Ukraine and Russia but let’s hope that doesn’t happen.

Here’s the % over the 200DMA going back to 1996. We are stretched but we can get more stretched, certainly do not have to, every sell-off, correction, bear market is different

VIX curve inverted for now, which simply means there’s a scramble for near term protection which is often a ST capitulation signal. Put/Call ratios are NOT at full extremes yet but they are certainly close. These are ST bullish contrarian signals in a very news-driven market. Great chart from Larry McDonald @convertbond on twitter in his Bear Traps Report today.

Just an update on the chart I posted from Schwab in December, there’s been massive damage to the stock market. It always feels bad, one never knows if a pullback will become a bear market but the data says, we have already had massive destruction, yes we can have further destruction but if you have a bigger picture and long term focus and are saving for retirement, these kinds of drawdowns are wonderful times to be putting money to work. Short-term, its anyones guess where markets will go. The tensions in Ukraine and Russia, inflation, earnings slowdowns, quantitative tightening, and the potential for China to try something similar to Russia in Taiwan are always possible.

Great chart from Bespoke on the corrections/bear markets in the Nasdaq. Just remember, the QQQ has radically outperformed the S&P 500 since 2007, so if one wants the potential for strong performance, one needs to be willing to assume higher periods of volatility at times and even better, to take advantage of that volatility when it appears to be extreme. The current drawdown in the Nasdaq is right about the average drawdown so while it sucks and feels bad, it’s just part of the program. If you don’t like heat, don’t travel to warm climates, its just that simple.

Tech has been the top performing sector for 3,5,10,15,20,30 years. Maybe its because of a falling rates tailwind but its primarily because of the innovation and revenue growth opportunities Tech offers. For most professional investors, Tech has been a persistent overweight, that’s clearly been a smart call. Now, the underweight to tech is quite prevalent, yes fund managers have been even more underweight tech but those were often some of the best buying opportunities so be careful how bearish you get here on tech. For me, Tech is a buy on every dip from here.

AAII Bullish Sentiment is in the dumps, yet more contrarian bullish signals even though we have so much to worry about. Tick tock the boat is getting too lopsided bearish.

There’s always a chance that an inflationary regime is NOT what’s in store but a more STAGFLATIONARY regime. Stagflation is when economic growth is slow but inflationary pressures are stubbornly high. Yes, this is mostly man-made, thanks politicians and policy makers all over the world for a massive over-reaction to Covid. This time around, if the Fed gets too aggressive, I do not believe they will, they could cool the economy to the degree that layoffs begin to rise and stagflation really bites when unemployment rises, growth cools and inflation stays high. For now, the employment picture is full but wage pressures are real and will be lasting. Here’s what the stagflation environment looked like in the 1970’s period. There were some real bear markets in 73/74 if memory serves me but no two periods are every exactly alike.

The indexes, particularly the Nasdaq and growth stocks continue to struggle catching a bid for more than a few hours or days. No one knows when this will change but it will change at some point. There’s some real value building inside the index, particularly in the mega cap, high quality portion of the Nasdaq. We just need more clarity and the removal of some big uncertainty. Lots to worry about currently and markets and stock action reflects this. The best long term returns are born from terrible market environments however. Here’s an interesting look at the Nasdaq Index and the spikes in the number of new lows looking backward. With the exception of the 2008/2009 time period and thus far since 11/30/21, the forward 1 year returns in markets and particularly the QQQ were generally quite positive. Anything is possible though, we never know how far this correction goes but with some clarity and uncertainty, and likely in the form of Russia cooling down and Fed tightness being less than expected, the forward returns should be better than the current poor sentiment indicates. That’s why I’m selling some defense on big red days and adding to the offense basket of great brands. This dollar cost averaging strategy should pay well looking out 1 year+.

Week of February 14 Market notes

Monday, February 14: That would be nice Sean, I hope you’re right!

As of last week, there’s still $4.59 TRILLION sitting in money market accounts not losing anything other than via inflation but certainly NOT earning anything. Leave your money earning nothing for a long time at your peril folks

JPMorgan Chase & Co. strategists led by Marko Kolanovic say global markets are pricing in an aggressive wave of monetary tightening this year that’s unlikely to materialize in full -- reinforcing the allure of stocks tied to the economic cycle.“We believe risky asset markets have mostly adjusted to monetary policy shifts by now,” the JPMorgan analysts wrote in a note to clients Monday. “Short-term rates markets have likely moved too far vs. what CBs will ultimately deliver in hikes this year.” The impact from these tightening moves from developed countries, the strategists argue, is likely to be partly offset from China, where the central bank is pivoting toward monetary easing. What’s more, growing Russia-Ukraine tensions have the potential to force major central banks to temper their hawkish stance, per JPMorgan. Kolanovic and his colleagues are steadfast equity bulls who favor cheap, economically sensitive stocks. Last month, the team urged investors to buy beaten-down stocks such as small caps after those companies priced in an economic recession -- spurred by a Fed hawkish policy mistake -- that’s unlikely to come true.

This GS chart is very important now: Normally when stocks stink, bonds, particularly long-bonds act as a stabilizer but with rates ripping higher, stocks and bonds are now highly correlated which makes it tougher to make money and buffer downside. Cash and non-correlating assets seem the only place to hide unless you can roll through the VOL and take advantage of weakness to get better prices.

Tuesday, February 15:

I think Alpine Macros says it best where the potential risks are now:

We continue to hold the view that the bond market has discounted too much monetary tightening, and the case for a sustained surge in inflation is not convincing. With the Fed becoming increasingly more hawkish and political pressure escalating, the central bank could rush into panic tightening. This usually spells trouble for the economy and stock prices and tends to invert the yield curve quickly.

This is exactly why I have been saying that I simply do not think the Fed, who knows all this already, is willing to drive the economy into a ditch simply to try and drive demand for good and services lower, drive consumer sentiment lower, drive home prices lower, simply to get inflation down which will come down on its own. Consumers will not sit and get fleeced over and over, the cure for higher prices IS higher prices. We are already seeing the effects of this play out. Earnings reports here and in April will reflect some easing of demand across most of the economy. Pushing too hard at the very minute demand is easing will just add more problems to the problem basket! Sooner or later, the Fed will pivot. Maybe asset prices will be lower first but when the pivot happens, buy everything that’s not nailed down folks because there’s so much bearishness and so much money short and sitting in cash that it will all run through the narrow door quickly to get back invested. These rubber band moves work in both directions. It’s on the WHEN that’s unknown. This should keep the fed on its heels.

Great notes and charts from Michael Cembalest JP Morgan:

The more important question is whether a recession is coming, which is way more predictive of a deeper sustained rout in equity markets. And on that front, I do not see a recession in the cards for 2022. I still think US real GDP growth will be ~3% this year as production rises to match higher levels of consumption. The latest capital spending surveys still point in this direction.

Rising costs by themselves do not result in lower margins and poor equity market returns; from 1987 to 2022, equity market returns were almost identical regardless of the level of median wage growth

The average stock in the NASDAQ is now down 42% from its peak, with many down 70% or more.

If we do get a 50 bps Fed hike in March and some additional equity market capitulation, that could represent an attractive equity market entry point. We’re getting closer to one now even without that.

Here’s some important charts:

THE MOST IMPORTANT CHART REMAINS: THE EXTREME POSITIONING FOR A MASSIVE RATE HIKE CYCLE FROM THE FED, ANY PIVOT FROM BEING THIS AGGRESSIVE AND THERE WILL BE SOME WILD RE-POSITIONING OF MASSIVE ASSETS. What got clocked the most, could see the swiftest revival.

Great charts from Goldman Sachs: There’s a wicked cap-ex cycle coming and maybe asset heavy businesses could play catch-up in performance versus asset light ones?

Week of February 7 Market Notes

Friday, February 11

Great chart here from Larry McDonalds @convertbond on Twitter: The last time inflation was here, February 1982 - the Fed Funds Rate was 15%. Just to remind you of how out of this world our policy makers truly are. THEY created all of this inflation and now THEY are begging the Fed to fix their mess without, of course, admitting THEY are the creators of the mess.

Here’s a historical look on the last period of high inflation. We actually had two periods of rising fed funds, rising CPI and equity spasms because of these things: 1972-1974 saw three major supply shocks—rising food prices, rising energy prices, and the end of the Nixon wage-price controls program—each of which can be conceptualized as requiring rapid adjustments of some relative prices. All Nixon did with price controls was calm inflation for a time only to see it go parabolic afterwards. During this period, the stock market was a dreadful place to be. CPI and Fed funds fell precipitously from their peaks just as the market bottomed in late 1974 while we were in a big recession. The S&P 500 fell about 42% from 12/29/1972 to 9/30/1974. From the bottom in late 1974, the S&P 500 rallied strongly +70%~ with CPI and fed funds falling to their lows by the end of 1976. Then we had the 2nd bout of real inflation where CPI rose from about 5 (its 7/8 now and likely not going much higher) to a whopping 15% CPI in mid 1980 where the equity markets bottomed in the recession while fed funds was highly volatile between 10 and 18%. The inflation rate, a mere 1 percent in 1965, hit 14 percent by 1980. Unemployment trended up from a low of 3.5 percent (annual average) in 1969 to 9.7 percent in 1982. During 1980 and the 1981-1982 recessions, stocks were volatile as one would expect. Bottom line, there is a massive amount of uncertainty currently and the markets hate that uncertainty. The fed has a history of NOT letting too much uncertainty stay that way. They can’t reduce rates and they can’t fix man made, policy driven inflation so this is a very tricky spot for the fed and there aren’t really any comparable periods like today with the pandemic. The U.S. has about $30 trillion in debt so will we allow rates to go vertical and stay high knowing we have massive funding costs if we do? 100bps in rising rates causes an extra $300 billion in debt servicing needs. At some point, allowing this to happen for too long starts to eat away at our credibility and our ability to service debt without having a currency crisis. Again, the fed is playing a dangerous game and I simply have a hard time believing they will follow through with all their intentions given the major consequences that will occur. Here’s the chart of the CPI, Fed funds, and the S&P 500 price action from early 1970 to early 1990 for perspective in this wild period.

Heres the irony, from March 1978 when CPI was about 7 where it is now, fed funds went from about 7% to 18%, CPI rise from 7 to about 15 and the S&P 500 went from about 90 to 140 when CPI peaked in March 1980. So the S&P 500 went up 55% as all these inflation measures and inter rate hikes were happening. Oh, we also had a recession in early 1980 too. Even as fed funds continued on their path to 18%, the CPI headed back down to about 10 as we entered the next recession from mid 1981 to late 1982. BTW 1982 was the beginning of the greatest and longest bull market in history. Yes things were different, life was cheaper but demographics of the baby boomers looked an awful lot like the millennials and GenZ right now. Something to ponder as you get super bearish here.

I’m simply going to continue to pound the table on the impossibility of 5-7 rate hikes, unless your base case is the fed to crash the economy and markets. Thats a tough one to believe imo. Great tweet here.

I maintain, the Fed and our politicians created this mess, and they are playing a dangerous game. Consumer spending is 70% of GDP and consumer sentiment today hit 60, it was 55 in the depths of the financial crisis of 2008/2009 for perspective. Yes, sentiment this low is typically a wildly bullish contrarian signal but that could take another few months for much of the inflation data to start feeling LESS BAD but still overall not great. The politicians will never tell you they over-reacted and created your pain, but we know the truth. The second sentiment chart shows sentiment by income bracket. Clearly, it’s the lowest income bracket that’s feeling this pinch much more. As an allocator, I have exposure to the brands that serve this cohort and have already chosen to absorb a lot of this pressure to try and keep costs as low as possible, margins will shrink for a bit but loyalty from customers will pay dividends for many years. It’s the stock market and home market that will affect the upper income cohorts more.

The market now expects 6.5 rate hikes to happen in 2022, all at a time when consumer sentiment is back to 2011 levels and close to 2008/2009 levels, inflation is high and economic data is rolling over. Good luck with that expectation,, it will NEVER happen unless one believes the Fed intends to crash the stock market, create a wicked deflationary pulse to halt demand for goods that are not in supply and drive the US economy into a recession. Seems like a silly thing to do after spending trillions to “save the economy” doesn’t it? If that’s the final outcome, we will have a new data series that has NEVER happened before. Jerome and his band would make even Paul Volker blush.

Wow, talk about proof of major policy errors and over-reacting to Covid all over the world. Now we have a new data-point for what WILL happen when you drop money from the sky and close economies, prices of goods and services go parabolic. Why? Because consumers have spending in their DNA, dah. This is a horrible inflationary chart but it’s clearly NOT sustainable because consumers will just trim their spending on things they don’t absolutely want or need. It is self-correcting but the Fed and politicians will clearly over-react to this new situation and make things worse. Here’s the good news: stock prices could come down further but that allows long-term investors the opportunity to buy great businesses, aka brands on mega sale. The process never feels good, but the outcome is truly wonderful cost basis.

Thursday, February 10

Well, we got the hot CPI print, it really wasn’t a big outlier and well within the range expected and the market opened down and rallied pretty hard for part of the day. UNTIL Bullard spoke and talked about wanting 100bps in hikes by June and even hinting that an emergency hike before March could be possible. The algo’s loved that, investors not so much, the markets promptly reversed and ended near the lows of the day. Clearly all the Fed governors are using the algo’s and markets to do as much of their dirty work as they can until they actually hike rates. The more the market prices in, the less they have to do, the better off the economy will be. I think it’s that simple even though it will cause wild volatility to continue until we get the actual clarity the market needs. Markets hate uncertainty and for now, the Fed wants the uncertainty so the market does the heavy lifting. This is a dangerous game they are playing though, as you will see from the 10’s/2’s spread. An inverted yield curve and recession probabilities increasing is NOT what they or us want so they better get really good at walking this tight rope for the next few months. Thats why we all need to watch the HY spreads here, we are at trough defaults, she can only go 1-way from here. Doesn’t mean we need a V bottom and go up, spreads can stay tight for years and years but if the Fed really does make a policy mistake, we will see it in HY spreads widening and breaking a multi-year downtrend. For now, that’s not happening.

This chart I really find interesting from @jasonfurman on Twitter: This is from the Atlanta Fed Wage Tracker, real wage growth by quartile. Good news: the lowest income cohort is finally seeing positive wage gains. Bad news, it’s likely NOT enough to keep up with these price increases so they are still likely feeling the pinch. Other bad news: the 3rd and highest quintile income cohorts have NOT seen any wage increases in general while their cost structure is rising. Now, many of these families have some wiggle room but there’s no doubt they are spending more for the same daily activities. Over time that adds up and in time, if this continues, consumer WILL start taking actions to mitigate the rise in their costs. Thats NOT good for consumption, NOT good for earnings beats, and NOT good for markets. Companies that keep hiking prices to combat lagging rising prices will one day meet a demand shortfall and then they have some real decisions to make. Let’s hope their input costs are lower so they can reduce prices and not see too much margin degradation.

Tuesday February 8

Well, demand for hedges has rarely been this fierce. These tend to be reasons for contrarian buy signals but for now we just have to wait for the March Fed announcement. Personally I wish they would just get the first hike out of the way and give the market some more clarity. Historically, unless theres a massive negative surprise, all this hedging tends to keep the market from having a significant further drawdown. I’ve also posted some of the great Sentimentrader charts from Twitter. I do not know when or IF but I do know that this amount of negativity and buying of protection, I’ll assume because of a policy error, economic slowdown and Russian invasion, is likely to end up being the catalyst for a positive surprise that makes investors-big and small-realize they are way too de-risked for the actual outcome we will see. Maybe the masses are correct this time, I just have a feeling that positioning is incredibly off-sides and the re-risk will be just as violent on the upside as it was on the de-risk to the downside. Time will tell.

Im generally NOT a seasonality guy with the exception of major holidays etc and with all the Fed meetings and inflation data, etc, its hard to have any faith in seasonality strength/weakness for 1H 2022 but here’s the current chart, it says we have bottomed and will see some chop but not make a new low before heading higher. I’ll take any shred of positivity I can get these days!

Monday February 7

The EU is now getting more hawkish on fighting inflation. That’s new and worthy of note. It certainly gives on pause about increasing exposure to European equities for now.

Earnings score-card for now:

The beats are falling from an abnormally high number, I suspect we have 1 more quarter of an easing of beats until comps get easier and GDP normalizes a bit further. For the rest of the year, we will likely see the tide going out and we get to see who’s naked. That’s about as good a situation for active managers as it gets folks. A focused portfolio of the have’s should perform well versus an over-diversified basket of the have’s and have nots.

The big corporate buyback window opens again next week and will stay open until mid March per Goldman Sachs. Let’s see if that persistent buying helps stabilize these low volume, air pocket moves when buyers have been on strike and corporations were black-out from buying.

A wonderful history lesson here: I analyzed 5,10,20,30 year periods to see which sectors seemed to rise to the top and outperform the S&P 500 and not so shockingly, Tech and Consumer Discretionary are consistently the top two sectors. Why? Well, likely because we have the worlds largest economy which is driven by the consumer and technology is at the center of everything businesses and consumers do each day. Everyone has plenty of Tech exposure but virtually everyone is chronically underweight the best consumer brands. It’s not an opinion, I see it by analyzing active mutual funds and through the sector ETF’s and even in the weightings of sectors across the major indices. All of them do not have sufficient exposure versus how powerful the consumer is for the economy. Don’t be underweight 1 of the 2 top sectors short, medium and long-term folks. Make sure you have some consumer discretionary exposure.

Style factor performance: Current market still favoring defensives even if they are mostly more expensive than high quality growth stocks with much better growth, margin, ROE, FCF, characteristics. The below image is our Core Brands SMA which is an equal-weighted portfolio using 3 multi-factor baskets: momentum, operating kings (growth stocks), and sustainable yielders (defensives and dividend stocks). Sustainable yielders over the last 6 months have performed very very well, a very big change from the laggard position it has generally had for the bulk of 5 years. A sign of the times. Below the performance chart is the current portfolio so you can see which brands are in which style factor category.

Week of January 31 Market Notes

Friday February 4

I know I har alot about how expensive the market is but here’s some real evidence around rate hikes and valuation regimes versus where we are today. Is 22x for the broader market crazy expensive with rates at 1.9%? I just don’t think so. In 1999, the P/E was 25 on average with a almost 6% yield on the 10 year. Plus, after many of the most expensive and speculative companies have come down 30-85%, alot of that speculative excess has already happened. Doesn’t mean it’s over, it just means the bulk of the damage is likely done. Companies will come and go but the best brands with the best balance sheets serving the most important consumption categories will just keep on trucking.

Today is a good day to take a look at the overall economic data to show trends and levels.

• Largely earnings are coming in fine, estimates though are coming down as inflationary pressures, wage pressures and input costs are causing margins to erode for many businesses. Thats why we focus on pricing power so much right now.

• Leading economic indicators are easing off from very high and unsustainable levels but still largely attractive - this is a ROC slowdown NOT an actual real slowdown, thats important.

• Jobless claims are low & the jobs report showed perhaps those that have left the workforce and were living off savings are finally seeing those savings dwindle so they are taking jobs. That helps with consumption given new people with income to spend.

• Retail sales is still strong, they are always volatile month to month but we should expect some easing of retail sales given how high they have risen from stimulus payments. Again, a ROC slowdown should be expected but NOT a real and lasting slowdown. Consumers are healthy overall even if they are getting squeezed from inflation pressures. It’s lower income consumers that are really seeing the pinch, they are also the cohort with the best wage gains so some of this will be offset but largely, these people are feeling some pressure to tighten their belts and/or begin to add credit card debt to help finance through this pressure.

• Consumer confidence, I’ll use the Univ of Michigan, is very low, primarily because of the inflation issues. As they ease, and it will take another year, confidence will rise again. Having strong job prospects and home price appreciation can offset some of the low confidence from inflationary pressures.

• ISM & ISM services have already seen their cycle peaks and are easing off, again a ROC slowdown versus a problematic slowdown unless the Fed decides to get tighter into this slowdown.

• Credit card and auto loan delinquencies are still very low for now

• HY credit spreads have widened lately but they were abnormally low to start and they have not broken any meaningful trend lines yet.

• CEO confidence is largely in the upper quartile so no problems there.

• Small business confidence has fallen a bit as the ability to find workers has been diffiicult. That’s why we have largely moved UP in market cap and focused on the companies that seem to be able to hire the workers they need.

• AAII bull/bear spread, we recently hit a low extreme meaning the bearishness was very high relative to normal times. At extremes, those tend to be positive contrarian indicators. So far that has worked again.

• Stock breadth is still troubling as uncertainty remains, less and less companies are performing. This will change with more certainty.

• VIX is still abnormally high >20 confirming the high degree of uncertainty. Trading opportunities are good in uncertain times while buy/hold tends to chop around and go nowhere with a potentially downward bias.

If this chart was describing a company you wanted to invest in, I suspect you would be very interested in that investment. Massive amounts of assets, not a ton of liabilities overall. Yes, income cohorts look different but overall, the consumer is very healthy these days. That bodes well for continued spending even though we know it’s always lumpy

The Fed is likely more focused on real yields getting back to the zero line than the absolute level of inflation. We have clearly had a taper tantrum similar to the 2012/2013 region in the bottom pane of the below chart but real yields are rising from deeply negative levels back towards the zero line. The fed has been masterful at talking real yields higher without having to do any actual tightening yet. This is another reason I believe the Fed will not have to hike the way the market anticipates which offers a positive upside surprise for risk assets at some point. Lets just get the first rate hike over with already!

Retail sales: ok on a ROC basis, everyone should expect retail sales to fall from unsustainably high levels before it gets back in a volatile range. There’s still >$1 trillion in excess savings, $2 trillion by some counts so abnormally high retail sales could linger for a bit longer. That’s alot of money that could continue to trickle into consumption until normal arrives. But nobody should be shocked when they see a lower retail sales report or multiple reports. The sky is not falling, we are just normalizing within a solid range.

I’m going to be as loud about this concept as I can, not that the Fed will listen or care but it’s really important to the “the fed has to raise rates and get tighter monetary policy asap” rhetoric. Great comments I’ll echo from Alpine Macro:

Tight money is the wrong tool to address supply-side problems. All this will do is increase the risk of more stagflation (stubborn & higher inflation with slower economic growth). Be careful Jerome, economic growth is beginning to normalize so rates won’t get away from people and there’s no need to tighten any where near what you have stated. Expectations are way over their ski’s and need to come down for this tightening cycle. The cycle is about to mean revert.

Tuesday Feb 1 - Some great charts from Bespoke - check out their subscription products, they are very good!

This needs explaining: Retail sales likely needs to ease further, simply because the above average spending is not sustainable. With gov’t checks now gone, lower income consumers should start to feel the pinch of higher prices and less money in savings. The mass affluent and wealthy, for now, are still spending well and we have not seen any evidence of a slowdown from this cohort of consumers.

Home improvements and the love of our homes is a big theme for the Brands strategy. Home affordability has certainly taken a hit with higher mortgage rates. New buyers with no home gain to sell have it much harder than a home seller of an appreciated asset that rolls that big gain into another expensive house. With the housing stock being on average 40 years old, the need for constant maintenance should drive demand for HD, LOW, SHW in particular.

Why do we have big positions in Blackstone & KKR? The chart below is a key reason. Institutions and retail investors are in the process of moving a portion of their assets away from high interest rate volatility and low yields and returns. That market is absolutely enormous, this is likely one of the largest waves I have ever seen and it’s why BX raised $270B new assets in 2021. They will manage over $1 trillion by the end of this year and they all have hundreds of billions of dry powder to take advantage of the next turmoil. You want to own the sharks folks, they always win in the end! Who wants no hope of total return with low yields and 2-3x the volatility they are used to? That’s why these PE brands are raising so much money and collecting such attractive fee income. And 45% of it currently is permanent capital.

Clearly there’s a ton of uncertainty and many views on how aggressive the Fed will be and what the trajectory of the economy will be post-covid BUT here’s some data on forward returns when the market is this volatile. Bottom line, we should expect more VOL and chop for a few more months unless we get more clarity from the fed and so positioning can be right-sized but over a full year, the chances of a decent return are strong. The chart below it states the same result by measuring poor sentiment and forward returns. I know people love to buy when everything is calm but the best returns come from buying important thematics, consumer spending is one, when they are on mega sale. This is the only industry I have ever know that loathes good stuff on sale and prefers to pay full or inflated prices. If its the same merchandise, choose to buy when it’s on mega sale, please!

Week of January 23 Market Notes

It’s not more simple than this: Tighten monetary policy into economic slowing and it flattens the yield curve. Rates fall, curve moves towards “inverted”, so Jerome is NOT doing all the monetary tightening he is hoping to do, the cycle, the data, will not allow it. The massive amount of debt and higher interest payments will not allow it. That realization brings massive & different positioning back. The end.

The market is very oversold and sentiment is quite stretched at the moment. We have bear market price action for now and the most robust rallies happen almost exclusively in bear markets. With the VIX up around 30, this simply means we should expect wide swings in stock prices on an intra-day basis. Today was no exception, the market closed Thursday at 341ish on SPY, bottomed at 330 early in the day and closed on the highs around 351.9, a roughly 6.6% swing. This action is the. hallmark of bear market trading but its also the hallmark of a market with positioning highly off-sides IF a new catalyst or narrative forms. What could that be? As I have said over and over, if/when the market does the real math and connects the dots, it will realize the Fed just can’t be as aggressive as it has said it will be and that realization will drive one epic re-allocation of capital to hated sectors like tech and consumer discretionary, particularly the most relevant, blue chip mega brands. It’s coming, I have no idea when. The below headline from Fed Governor Kashkari highlights what could be in store.

If you’re selling stocks with the AD line so washed out, you’re really really really doing it wrong. Now is the time to be greedy long if only for a wicked oversold bounce!

Friday, January 28

Why doesn’t anyone ask and answer the question that seems so obvious? If the Fed is so worried about inflation, why wait until March to do the first rate hike? Why are they still buying bonds? Their actions are diametrically opposed to their views. Perhaps they understand Q2 will experience a soft patch, we certainly will not have 6-7% GDP for the whole year, the math does not work. I have said all along, I do not believe the Fed has the appropriate air cover to be as aggressively tight as they have indicated and that they are desperately trying to talk inflation down and let the market do their work for them. Most of the economic data has already seen a ROC slowdown so as the economy normalizes toward a more sustainable & trending GDP range (2-3%), their rhetoric around rate hikes should change and once the market realizes these aggressive hikes simply cannot happen, there will be a wicked rotation back into blue chip growth stocks. Heck, even the most speculative growth stocks might even catch one wicked bid as rates fall and money rotates into anything with an above average growth profile. I believe it’s coming, now we just need that soft patch the market is already sniffing out to appear.

The market has already experienced a bear market, it’s only the indexes (other than the small cap index) that haven’t experienced it yet. This is only the 7th time since 2000 we’ve seen this few stocks over their respective 200 day moving averages. We can really get washed out towards <15% of the stocks but we are likely 2/3 through this horror movie. These are wonderful times to upgrade your portfolio as the highest quality, most important consumption brands go on mega sale. Be bold, be greedy when others are filled with panic. That’s when you get the best buy prices.

Speaking of mean reversions, the pent up demand for services like travel, recreation and entertainment and the spending that likely goes back into these categories could be epic. The timing is always the hard part as policy around viruses and travel restrictions stays restrictive. It is not a matter of IF but only WHEN the huge demand spike arrives. The light blue line shows how depressed leisure service spending still is. Consumer behavior does not change, there is a huge boom coming, and politicians are getting the message that they cannot hold back the bulls for much longer.

Because of inflation and consumers getting squeezed daily on virtually everything they want and need, Consumer Sentiment is back to 2011 levels and not that far from 2008/2009 lows. Yes, it could mean spending could slow as consumers defer purchases as they get squeezed, given Retail Sales is still well above long-term trend lines, that’s a likely outcome over the next 90 days BUT there’s now a ton of room for a recovery in consumer sentiment and spending if we see some of this inflation cool a bit. Seeing the stock market stabilize would help immensely as well. For now, it’s a very odd period in time. Wages and wage growth are higher than in many decades but much of those wage gains are being eaten away by higher prices for goods and services. Only a demand shock and a huge opening of supply will force companies to lower prices. With input costs staying high, companies need to pick a lane: 1) absorb some of the higher costs to keep consumers loyal and spending with them (target, Walmart, Costco, etc) or 2) try to keep corporate margins high, hope you have strong pricing power and high demand for your products/services and rapidly lower prices on the first signs of demand slowing. It’s a tough decision to make, the market doesn’t like margin erosion because its too short-term focused, longer term, that’s what drives loyalty and strong, recurring revenues. Short-term pain for long term gain is the decision I would choose if I were running a consumer retailer.

How do we know GDP will ease meaningfully in Q2? Inventory replenishment was a key reason for big GDP and that will likely continue to normalize lower at a time when demand could also ease as consumption trends normalize. Remember, Covid has created massive distortions and 2nd and 3rd derivative knock-on effects that are creating havoc inside equity markets. All of these effects are in the process of normalizing but it will take time. Here’s a great note from Wells.

Important: We are in earnings season currently and almost every call I listen to talks about new price increases being implemented asap. For many brands, these price increases will drive a potential slowing of demand but for in-demand spending categories and the 800lb gorilla’s in these categories, that will mean demand stays high and revenues, earnings, and margins stay elevated. Even better, as supply issues ease, input costs will ease and many price increases will stick which allows margins to expand until demand destruction arrives. If you are Sherwin Williams with strong demand for your products and you implemented numerous price increases, your margins get hurt early and they rip back later. That benefit accrues in coming quarters so you buy these type of stocks into weakness for positive upside surprises later. This game is about chess, not checkers and thinking 7 steps ahead gets you paid well. Heres a great chart from Hedgeye showing that inflection coming.

Thursday January 27

Most interesting part of Bill Ackmans 3.1m share buy of Netflix, and I love that brand and his call on this stock, is he chose to swap most of his rising rate bet into a blue-chip growth stock. The inference here is he thinks the bulk of the rise in rates is now complete and what works in that environment is blue chip growth stocks. Just so happens NFLX has the most damage and his team thinks the skew is now with alot of long-term upside. Everybody wants to panic and sell AFTER the big correction, that’s doing it wrong, now is the time to be greedy. The two charts below highlight what sentiment looks like now, its horrendous, exactly the time to start being greedy. That’s how you get paid! 23% bulls today, 53% bears, that’s quite an extreme case. It can get slightly worse as the red circles indicate, but my gosh, these are the places where buying equities has paid people on a forward 1+ year basis - 2013, 2008/2009, end of bear market in 2003, etc.

Wednesday, January 26 - FED DAY

Well the markets and VOL are on edge today as we wait for the Fed to give some more guidance on rate hikes, trajectory, QT etc. They see the economic data getting soft, they have to know that GDP, retail sales, etc is inflated so we will ease further into Q2 on a rate of change basis. Inflation data has already peaks so for now, the market is doing their work for them. Will they push harder in the face of all this obvious data? I would be shocked if they do but perhaps they need to stay firm for another month until they have a rate hike meeting. Or they could surprise everyone and hike rates today and tell us they will stay put and watch the data to see how the economy reacts. Regardless, VIX is elevated and until we have real clarity should stay elevated so be prepared to have wider swings on a daily basis for now. Trade is you can, these are decent trading environments. As the chart shows, YTD is the worst start to a year EVER. In my experience, these kinds of extremes are eventually followed by extremes in the opposite direction, the WHEN is always the hard part.

Here’s what the market is expecting from the Fed currently - 4 rate hikes in 2022 (I’ll take the under big time). Maybe the prices are reflecting this, maybe they are not, I’m not smart enough to know how the madness of crowds thinks. I do know however, anything less than these aggressive moves and the market is VERY OFF-SIDES with how bad price action is. Time will tell. This is all a game of expectations, positioning and reality when compared to expectations.

January 24

Well, markets continue their sell-off today. Interestingly, the economic data continues to be soft and inflation data rolling over so will the FED really stay aggressive in the face of this obvious easing of conditions? The market is saying yes but I’ll take the other side of that trade. From a consumer perspective, here’s what BAC says and P&G, the consumer is fine, absorbing price hikes for now and continues to spend. Yes, retail sales needs to mean revert, its like 20% above the long-term trend, thats what happens when you drop money from the sky, people spend it. Some businesses will see easing of business trends which is why we are not speculating in the 2nd and 3rd tier brands and spending categories. People with means are less sensitive to price increases generally.

Yes, lets be aggressive with tighter monetary conditions when data rolls over Jerome.

Most of the time, everything stays in a band of “normal” but in the investment business, when things go to “extremes” there is often a wonderful opportunity to fade the extreme for a move back to normal. Whether it’s a trade or an investment, we never know in advance but when the highest quality, most profitable segment of a key industry like TECH gets this hated, it’s time to start catching falling knives. I started last week and I’ll continue adding this week to the high quality, high profitability growth brands. The boat is loaded to one side, all we need now is a catalyst. Maybe it’s a max oversold reading, maybe it’s the Fed this week hinting at the possibility that easing economic data and inflation readings could keep them from being as aggressive as they indicated a few weeks ago. If/when this happens, my heavens what a vicious and quick re-rating it will be in tech. I suspect even the garbage tech will have a rip back but I won’t play there vs adding to the long-term leaders of key consumer areas. All the signs for a sentiment extreme are present at this point. The more extreme this goes, the more wicked the snapback when a new catalyst appears. Sentiment chart via Bespoke.

Week of January 18 Market Notes

Friday, January 21

Options expirations cn be volatile and this week with huge open interest lower was no exception. Mid-day the market started to sell-off and it finally felt “pukey”, technical term. Not full puke but like we were ready for that good ole fashioned margin call is coming puke before a very good buying opportunity. I think it’s fair to say most stocks look like bear markets so lets assume we are indeed in a bear market for now. It means that markets are very volatile, VIX spikes happen with frequency, VIX stays over 20 and even 30 for longer periods of time and THE BEST RALLIES HAPPEN ALMOST EXCLUSIVELY IN BEAR MARKETS so now is not the time to panic sell. There will be some form of oversold bounce likely next week on any further selling, that’s a better time to buy for a trade, or add for long-term accounts and trim/sell stocks on the bounce that you are not fully committed to. Terrible markets are always the best time to upgrade your portfolio, we are in one of those times currently. Here’s the end of day breadth numbers, we are at the former low while index prices are even lower, one flush and we get a max oversold reading to buy and trade. At just 8% of stocks trading over the 10DMA on the Nasdaq, that’s a pretty extreme reading and fit for buying on any further deterioration. The second chart shows where we bottomed last time in the Nasdaq, aka right at todays levels.

For now: The Buyer Strike Continues

The Fed is letting the market do its heavy lifting = the Fed will have to do LESS than market expects=Buyers will be back.

Tuesday January 18

I wanted to make sure everyone knows exactly where I stand with the Fed, inflation, interest rate hikes, and the stock market. Consensus is wrong. Period.

In 2020, the U.S. was at full employment

There was little inflation

Supply chains were open

Shipping lanes were open and orderly

Manufacturing lines were largely working at full capacity

Labor shortages ex-very specialized jobs were not present

Wage inflation was largely contained

China/U.S. tensions were present and getting worse on the margin

Out of nowhere a global pandemic arrived, they called it Covid-19

Covid is clearly a man-made virus

Bad covid policies across the globe begin to emerge

The U.D. Fed and politicians radically over-react which begins to set off a chain of inflationary events

Money is dropped from the sky; people get paid to stay at home & spend free money

The Fed prints trillions of dollars to buy bonds and support the economy

Consumer savings goes parabolic as spending is forced to be curtailed

Supply chains shut down at the exact moment when consumer demand for goods rips back

Too much money chasing too few available goods creates epic man-made inflation

Shipping lanes stay clogged, supply chains stay clogged, prices stay higher for longer

A massive number of Americans use Covid as a reason to pull forward retirement

Other workers stay out of the workforce until their excess savings begin to dwindle

This creates a historic worker shortage which drives up wage inflation

Workers having more money to spend ultimately proves beneficial to consumer sending

Overall consumption trends stay within the long-term range which keeps U.S. GDP positive

The Fed gets pressure to “fix” the man-made inflation

Politicians are the very people who created the inflation through poor Covid policies

The Fed, a private equity guy, realizes their toolbox cannot fix this man-made inflation

The fed tries to talk down inflation with increasing hawkish/restrictive rhetoric

Interest rates spike, equities sell-off and the market takes the Fed at their word

Markets do the dirty work for the Fed & we have the great re-set

One day, investors that sold stocks because of rising rates and a restrictive Fed realize there’s zero possibility of 3-4 rate hikes and balance sheet run-offs because growth has slowed, and inflation was already peaking

They realize selling stocks is idiotic and begin buying hand over fist, as groupthink pivots from bearish to realizing how under-exposed they are to equities

Moral of the story: The Fed has no interest in tanking the economy to fix inflation that’s man-made. Their toolbox cannot fix what policy created. Normal conditions will allow most inflation to self-correct. Wage pressure & the inability to attract talented workers will be an issue for all but the best businesses/brands.

Selling stocks because of this narrative will be proven to be a very bad idea soon enough.

THE END

Very little of this inflation is sustainable so it will begin to roll over sometime this year with or without Fed help.

What drives asset prices higher? More buyers than sellers is the correct answer. So in 2021 we had about $700B into fixed income and $500B into money markets, I suspect more of the same in 2022 as equities puke so now we have an epic potential buying frenzy back into equities at some point. Whats the catalyst? The recognition that the fed cannot and will not implement its Paul Volker-like policies. OR markets tank further from here and stocks get too attractive to ignore. Tick tock, it’s coming, all we need is a match and the buying will be fierce.

The USA: Tough Q1/Q2 which turns into Goldilocks - Hedgeye current nowcast. Today’s correction clearly front-running slower growth next quarter. Stay strong - the sun will be out again & great brands will be on mega sale

Wednesday January 18

Here’s a snapshot of the corrections across the S&P 500, Nasdaq and Russell 2000 and frankly it does nothing to show the damage done to the “average stock” which is much worse. The good news: the market is well on its way through this correction, buyers just need to get engaged again because it’s a 1-way train right now and sellers/short sellers are driving the direction. Source Bianco Research, Jim Bianco via Twitter

Week of January 10 Market Notes

Friday, January 14

I’ve been talking about this a lot lately but today Hedgeye puts it best to describe what’s happening out in markets this year so far:

The Fed is set to start increasing interest rates just as inflation appears to be peaking or has peaked. If that doesn't make a lot of sense to you, you probably aren't alone. It could get ugly quick if the Fed overdoes their tightening (as they've been prone to do) especially if growth starts to slow. Perhaps this is what the QQQs (which are down almost 6% YTD) are telling us? Both the Fed and the market are telling you to expect rate hikes – you can see that in both the LOW-END of the @Hedgeye UST 2YR Yield Risk Range rising and in terms of the U.S. Equity market response to rising rates this morning (SPX futures down) – we made this call in Q4 of 2018 and we're making it again – raise rates into a slowdown and you’ll see more days, weeks, and months like yesterday. They made this mistake in 2013, 2018 and now they are at least telling us they will make it again in 2022. Dear Federal Reserve - inflation is as bad as it will get, it will stay higher for the year than normal but on the margin it will ease, you don’t need to slow economic growth by over-hiking into a slowdown.

I maintain, the Fed is not stupid, the hiked rates aggressively into a slowdown in Q4 2018 and I do not believe they have the will or the economic air cover to do it again so the consensus expecting them to be aggressively hawkish and drain liquidity will be disappointed and many of the positioning trades that have been put on expecting this tightening will have to be unwound and that will create quite a powder-keg of buying in Nasdaq type names. The only question is WHEN? I would prefer the fed just do a rate hike NOW and say they will wait and see how the data unfolds but perhaps we can have another month and a half of this uncertainty in markets until the Fed meeting in March. That is not preferred but they don’t ask what I think.

Here’s the situation we have no in markets, short-term cautious, as prices re-set, this cycle could stay for longer versus the parabolic blow-off top that tends to end the cycle for a few years. Charts courtesy of Stockcharts.com

Thursday January 13

Well it’s official, for now, market participants are selling every rally in high beta stocks. Last year, the indexes held up well and the stocks inside the indexes largely struggled. Now the Mega Caps are being taken down. Interest rates have stabilized around 1.75% on the 10 year, it’s the Fed and their persistent chatter about being committed to hiking rates multiple times this year. I agree they will be forced to hike once in March or before, their credibility is on the line. Frankly, I would prefer they just get the rate hike over now and give more clear guidance on what the market should expect for the first 6 months of the year. There’s clear evidence that inflation data has likely peaked and will slowly ease from here. Wage inflation will be sticky and there’s nothing the fed can do about that. The market is now trading as if the Fed WILL in deed hike 4 times and reduce liquidity. That’s alot of hawkishness in a very short period of time. Judging by the trading in markets today, the market is taking the fed at their word and reducing net exposure and particular growth stocks in particular. Unless we get something more concrete out of the fed before March, the next month and a half could be very turbulent. What’s the catalyst for a sustained rally? Earnings could serve as a temporary respite to the selling but for now, it seems every rally in high beta is a selling/trimming opportunity. When we see a real washout with <5% of stocks in S&P 500 and Nasdaq trading over the 10/20 day moving average we could have a great lasting buying opportunity. I’m watching the VIX & VXN and want to see if the VIX can stay under 20-22ish. Up to the 20/22 level tends to be the level at which buying dips makes sense or raising more cash and putting my trading cap on (>22 Vix). Not a pretty day for growth investors again today. I trimmed some expensive growth and added to defensive type brands I love like Target, Costco, Sherwin Williams and added a new position in Nexterra Energy, a utility with a sustainable energy component. Amazing company and a decent place to hide out for now.

Wednesday January 12

Very instructive for long-term investors. Given that we have a consumer led economy, I’ll bet the next 30 years has just as many consumer focused brands being in the top performers list, the names may change but the thesis of “the most relevant brands serving consumers” being top performers is a timeless thematic. 43% of the top performers were consumer stocks, the best “beat rate” for any sector, including technology.

The winners were: Monster Energy, Amazon, Pool Corp, Netflix, Apple, Starbucks, Best Buy, Lowes, O’Reilly Automotive, Ross Stores, Penn Gaming.

Read this a few times:

>40% of the stocks in the Nasdaq, not the Nasdaq 100 QQQ Index but the overall Nasdaq Index is down 50%+ from all-time highs. That might actually be worse than 2000 when the bubble burst and the nasdaq peaked. Rates were 6% then, 1.8% now - a very different time.

Short-term, the market is very oversold and for now, rallies will be sold as people are finally scared of risk. I’m not smart enough to know when the market hits its bottom but I am smart enough to know that there’s massive amount of fuel to be put back into risk assets at some point. I cannot do anything but add to my favorite brands with quality balance sheets and great growth opportunities.

Picture a rubber band being stretched from top to bottom until you are scared to death it will break and snap right back in your hands. Or picture a herd of cattle all running together right into the slaughter house. Then picture a few cows that pulled out from the herd and decided to eat the green grass around the fringe of the dirt road they were on. “They never saw it coming because they weren’t thinking for themselves” said one cow to the other. That’s what the current market feels like to me, particularly in the growth complex. Not the speculative, zero profits, zero cash flow part of growth, but the high quality, super profitable growth complex. In today’s world of big macro trade baskets, algo baskets, ETF trading, so many idiosyncratic stories get lost in the desire to extrapolate one’s view by buying or shorting just a few baskets. Short-term pain but long-term gains come to those willing to step out from the herd’s lane and carve their own path. In greener pastures is where we like to traffic. Right now, the narrative is so extreme, the consensus is so confident, and the price action is so dreadful that a contrarian can’t help but be excited about buying what the herd loathes. Hedge funds have de-levered much of their growth stocks (remember, in accommodative markets with good growth and tame inflation, they like to really lever-up 2,3,5x to juice returns and their fees), institutions have de-levered, retail investors, who tend to only own growth and crypto these days, have puked up their “compounders” but there’s over $4 trillion in money markets and $2.5trillion in savings accounts. Much of the growth complex has been lagging the value and cyclical stocks for almost a year now. Valuations got stretched, particularly in the most expensive part of growth, the differential in returns between growth and value got completely out of whack from historical norm, so the the differentials are now closing rapidly. There’s lots of reasons money has been rotating away from growers lately but the Fed making a major pivot last week that was completely unexpected by everyone is the newest reason for the extension of that growth sell-off. The Fed laid out a plan for “normalcy” and then without warning, highlighted they would accelerate their plan. Markets hate uncertainty and the fed just gave them some new uncertainty to think about and allocate for.

In the fed minutes, they now say they are seriously considering a rate hike as late as end of Q1 and starting to dispose of assets versus just not buying new assets which reduces the money supply, aka drains liquidity. So naturally, all those macro trades need to be unwound even further this week. The boat is crowded if you’re a growth bear. Today, I begin adding back to some of my favorite growth brands and growth thematics. With everything on sale and sentiment so terrible, I will do more of the same on every damn dip from here.

I simply do not believe Jerome Powell and the Fed want to see a complete unwind of all they have done in 2 years. They are trying desperately to talk down inflation and the market is now doing their work for them. If they are stupid enough to hike rates 3-4 times this year and go cold-turkey on monetary policy accommodation, well then, the markets have it right and stocks will go down further. Again, I simply cannot believe Jerome is that stupid, he remembers Q4 2018 very well I am sure.

Some of the most impressive growth managers are down 15%+ in the first week of the year, that’s a very rare thing, particularly after them having very tough and negative years in 2021. Short-term, the trend seems lower for growth but with the # of stocks trading over the 10 and 20 day moving averages well off the lows but the indexes making new lows)particularly the Nasdaq), a major positive divergence is developing. That doesn’t mean if we get more confirmation that Jerome has gone full Q4 2018 on markets that we wont see a new wave of selling to drag breadth down further, but my gosh the damage thats been done to very high quality companies seems quite overdone. I hate seeing this kind of damage and the charts are now broken for most growth stocks but as someone who likes using volatility to upgrade the portfolio for long-term gain, I do like getting the opportunity to add to my favorite brands on this massive dip. The VIX is +37% thus for in a week so we are almost at the rule of VIX +40% or more in 1 week, buy some stocks. Let’s see if Jerome doubles down on stupidity or walks back his latest views to calm markets.

Here’s what I doo know: there’s a massive amount of money now positioned for rising rates, a continued sell-off in growth stocks, concentrated exposure to banks, energy and other value cyclicals. If the fed end up being anything other than as hawkish as they have recently stated they will be, there will be an unwind of the above positioning that will take your breathe away. Investors of all kinds want to own quality, growth, high brand recognition and great balance sheets. When they go on sale, there’s always alot of money looking to get larger in this group of stocks. It’s not a matter of if, but when. Stay tuned.

Lets talk rates and fixed income for a minute - some good info from Lord, Abbett a great bond manager:

One must consider that short-term yields have already adjusted higher in anticipation of Fed moves. As of January 6, yields on two-year and five-year U.S. Treasuries—– which are more closely tied to Fed moves—have increased by 75 and 112 bps, respectively, over the past year, as the short end of the curve has been pricing in Fed tightening. Based on fed funds futures, the markets are expecting at least three and possibly four 25-bp rate hikes by the end of 2022.

This needs to be in bold: these are the expectations, the market is acting on these expectations so IF there’s any change in these expectations (It’s absolutely NOT going to be even more hawkish), the current unwind in the growth complex will be reversed in short order. To me, that kind of asymmetry is worthy of investing in AFTER the drawdowns we have already seen. It’s gone too far in the quality growth stock complex folks.

Here’s some great comments from a very smart, very successful growth investor today:

Week of December 27 Market Notes

Monday 12/27

Happy holidays! Well, Santa came after all and the markets ripped higher as shorts closed their positions and the low volume holiday week began. As we start the week, I suspect we will see a gradually trending up market but at the close Monday, the markets are a bit extended and need a rest. Given the sentiment data I posted last week, I suspect there could be one heck of a January effect in some of the most beaten down stocks. Market breadth continues to improve but with the understanding that there’s been some real damage under the surface of the indexes. On the surface, the yearly gains looks quite robust and one might assume that gains were easy to come by but that couldn’t be further from the truth. Here’s a look at the stealth bear market correction we have already had in 2021. The good news: there’s a ton of room for a “performance catch-up” by the 2021 laggards. Wouldn’t it be fun if the leaders of 2021 took a big breather and the laggards had wicked good January/February’s? As of 12/20/21, a whopping 68% of Nasdaq Composite stocks had at least a 25% pullback from the YTD highs. 89% have seen a 10%+ pullback and the average decline from YTD highs in the Nasdaq was -43%, that’s the epicenter of the correction/bear market but the damage across small-caps has been just as severe. I have plenty of great brands that have experienced at least a 20% pullback but wow, do I feel good about 2022 with the big correction already happening. It doesn’t mean the selling can’t continue but I get excited when great companies go on mega sale. You should too!

Are consumer’s too bearish about inflation staying high?

The next chart is interesting from a contrarian perspective. When consumer expectations get extreme, they often should be faded. Example: in March of 2009 very few investors wanted to add significantly to their equities as bearish extremes were everywhere, yet it was the absolute best thing to do. In late 2007, consumers were flipping houses, had too much debt and appeared not to have a care in the world and yet we were on the verge of a major financial meltdown. Currently, consumer expectations for high and sustainable inflation seem extreme as supply chains begin to improve and other inflation metrics appear to have peaked. If consumers are wrong and inflation has peaked (the blue line: should stay elevated for a while but inflation gets less bad likely from here) then their willingness to buy more durable goods and other goods and services should improve (red line)as prices ease and get more attractive. Overall, that’s a bullish sign with the current extremes we see in inflation expectations and the attractiveness of buying conditions.

Week of December 20 Market Notes

Monday 12/21

I’ll say it again, the rubber band is getting about as stretched as it ever gets, we are due for a wicked rally and it can happen at any time with or without any catalyst. It’s above my pay grade to know if it will simply be an oversold rally that fails and we make lower lows or if the rally will be the start of a more stable market with better participation. My bet is the latter, simply because the level of pessimism is currently not warranted and the selling has not been orderly, it wreaks of forced de-risking, de-levering, and a rush to harvest losses and pull forward cap gains under the assumption that the rates will be higher next year. I’m not even sure that will happen so it will be really silly if people sell this year and no changes to tax rates happen. The government wants to claw back as much of the money it dropped from skies in 2020 as it can. If you find you have too much risk inside portfolio’s, my guess is you will have a much better selling opportunity than selling low now.

Positive divergences are everywhere at this point. If this is covid related, why are travel stocks not making new lows? Indexes are pulling back but the number of stocks trading above the 10 and 20 day moving averages are not making new lows. In fact, most stock charts are showing higher lows at this point. All of this suggests, the selling pressure has largely exhausted itself for now and right in time for the actual holidays.

Major positive imo: Omicron. It’s spreading like wild-fire (bad) but its very mild (very good). Whether we like it or not, we all have a date with the virus and this strain seems the best one to get. If cases are going parabolic, that means we reach a more solid herd immunity quicker. Roughly 55 million people have already had covid. The vast majority of healthy young people will have no problems with the virus. People are clearly fatigued and ready to get back to normal life and the travel data shows no signs of a slowdown because of the recent surge in cases. That’s a major positive, certainly for the “recovery basket”.

I think the pain-trade for now is higher. Why? there’s been a massive amount of de-risking across retail, institutional, systematic investors and hedge funds. As the calendar crosses December 31, new years often bring in new flows and the performance clock begins to tick again and holding all that cash will likely not be everyone’s plan. Many charts are broken, sentiment is dreadful, the wall of worry is high and no one believes in the market right now. In my 30 years of doing this, that kind of set-up is rarely a bad time to be adding to risk. When everyone is giddy, that’s when I get very nervous, right now, it’s lonely on this side of the boat and I love when that happens!

Happy holidays, I’ll post some charts later this week, bearish or bullish, lets let the data tell the story. From the below chart from Hedgeye, it looks like Q2 in 2022 could be the low quarter from a GDP ROC perspective so adding some defensives in Q1 will likely be a decent idea. Remember, the data always changes so we have to be willing to be flexible as the narrative changes.

Week of December 13 Market Notes

Monday 12/13

Markets have become too bearish right now, that offers significant opportunity for investors and traders. Hedge funds have de-grossed, fund managers have done their tax-loss selling, cap gains have been pulled forward under the assumption that taxes will be higher next year, Covid flare-ups are creating concern and new restrictions, and worries about the Fed taper and rate hikes to deal with inflation has driven this rush to cash, hedging and defensives. I see all these worries and many of them I share but when the boat gets this loaded to one side, you start tip-toeing to the other side for a while. These are often the biggest opportunities for gains. The more extreme the worry, the more extreme the de-risking, the more aggressive the money comes back once there’s been a reason to worry less or if there’s a period where a lack of bad news could offer a sellers strike. Thats what I see for the rest of the year. There’s been massive damage under the hood of this car(market) and I think there will be an epic January effect as this rubber-band has simply been stretched too far to the downside. I’m now on “buy the highest quality consumption leaders on every rally in the VIX mode” until positioning gets more right-sized.

The Fed has been very consistent, they are data dependent. They recently told us in early November they will pull-forward the taper faster which spooked markets and has driven a lot of this de-risking to cash. In my opinion, the Fed is smart, Jerome knows this kind of inflation was man-made and cannot be solved by traditional rate hikes and less liquidity. He understands he is walking a thin line and if he is too aggressive, his actions could help push a fragile economy into a slowdown. He remembers Q4 2018, this I assure you. I think Powell will try to jawbone and talk inflation down with the potential to be more hawkish. He saw how quickly credit markets “un-froze” at the mere thought of massive bond purchases, he barely had to actually do anything but the problem got solved quickly. Again, this inflation is man-made from poor policy regarding how to deal with a pandemic, it cannot be solved by traditional monetary policy tactics because those will drive the economy into a slowdown while doing nothing to solve the inflation. Thats called STAGFLATION and that’s a very bad outcome. The Fed understands this IMO. SO here’s the opportunity now: Add more risk on every darned dip, the lower we go, the more aggressive and beta-centric I want to be. Why? the bear boat is too crowded and the rest of the year there’s a lack of negative catalysts that could hurt markets much further. Breadth should broaden out, the VIX should trend back towards the high teen’s and bearish positioning will have to get less bearish by adding more risk onto books. That’s my call and I’m sticking to it. The biggest risk imo is not the virus, it’s a continuation of terrible policies and restrictions as a reaction to the virus. If these continue, all bets are off and stocks might need to probe lower levels. Politicians and policy makers can restrict their way right into a slowdown if they keep acting this way. That topic is for another day, for now, let’s keep it simple, take advantage of any near-term weakness in stocks and stay up the quality curve and own stable, predictable businesses with high profitability and economic moats. But honestly, with how horrendous this tax selling has been, I think even the Ark, speculative names could have a heck of a month or two given how extreme the selling has been. Take out your darts and throw them hard!

2020: Brand Love Survey Results

I created a brands love survey this year to take peoples temperature on the brands that matter most in important spending categories. Below are the results, these are the brands that remain front of mind with consumers and therefore should be front of mind for investors who want exposure in certain spending categories. Cheers!

Week of December 6 Market Notes

Monday - 12/6 - This is the real story: If you remove the top 5 Nasdaq stocks, the nasdaq would be down about 23% YTD - this year’s market has been much harder than one would think, particularly if you buy growth stocks.

If you spend a lot of time watching the markets on a daily, weekly basis, you’ll agree the market doesn’t seem to have any memory from day to day. One day, the virus is a problem, growth is going to stall, the fed will withdraw too much liquidity at exactly the wrong time and valuations are a problem. The next day, re-opening stocks rip on big volume, growth will accelerate and the Fed has our backs. I’m sorry Mr. Market but the things that really matter do not change each and every day. Because we have a systematic, algo-based market, where thoughts and logic are not part of the buy/sell decisions, we have to get used to these short-term, wild swings in both directions. For active investors and traders, honestly this is a pretty good environment, but for investors, it’s important we don’t let one or two days dictate our sentiment. The markets will move up and move down, but largely, our lives on a daily basis are unchanged. The good news, sometimes when the VIX goes parabolic over seemingly insignificant data while the actual economic data is solid as a rock, you get a raging buying opportunity to buy the fear, uncertainty and doubt. If you let your sentiment drive your actions, you will typically buy high (when everyone is happy) and sell low (when everyone is panicking). Just remember: BUY FEAR, SELL EUPHORIA. If you forget everything else I say forever more, please remember this important quote. Today the VIX was down about 17% from Fridays parabolic close. Stocks ripped higher for the most part and the world was a much happier place. If we trade like most days this year, tomorrow the market will pivot again. Buying breakouts has not generally worked this year but I think breadth and sentiment is bad enough that buying deeply oversold stocks for a decent January effect for the next 3 months is a decent opportunity. For me, I absolutely love the 28 stocks int he brands portfolio, particularly with the sales I see right now.

Last Wednesday we had a breadth washout IMO. The number of stocks trading above the 10 and 20 day moving averages plunged to sub-10% which is very rare. Washouts like this feel very much like forced selling and capitulation which tend to offer wonderful contrarian buying opportunities. Friday of last week the breadth in the S&P 500 was much better than Wednesday and the Nasdaq breadth didn’t improve but didn’t deteriorate either. For now, the Nasdaq still seems to be the index with more problems but with breadth this poor, it won’t take much for breadth to improve which could give the index a lift.

At today’s close: breadth improved off the wash-out lows: S&P 500 # stocks >10 day moving average= 54%, # over the 20 day MA=36%. On Nasdaq # of stocks >10 day MA=23%, # of stocks >20 day=14%. Nasdaq continues to lag the S&P 500 in breadth recovery.

The style factor of high valuations is not working well which is likely why that cohort has experienced the biggest drawdowns YTD. Some of the biggest winners of the last 5 years are now correcting which is a great development for investors who like reasonable valuations and high growth metrics.

Wednesday 12/8-

Well, what a few days of strong up markets can do to sentiment. My heavens peoples sentiment changes faster than it ever has. Perhaps it’s because markets move so fast given the dominance of algo’s that trade faster than any human can think. They trade on news and short-term momentum signals so if I were a company I would lather my news releases up with as many “algo friendly” words and phrases as I could. Last Wednesday we had a breadth washout and Friday was a re-test that for the most part highlighted positive divergences even as price tested the recent lows. That was a decent sign that this market was way over its ski’s in bearishness and price was a coiled spring. Since Monday, we have relieved the max oversold condition but there’s still certainly more room for higher prices short-term. The CNN Fear & Greed Index bottomed at a bearish 20 and closed today at 40 which is still in “fear” territory. I tweeted last week that I thought the worst of the selling for the year was over and that we would likely not see these lows again this year. I still think that’s the base case for the next 3 weeks. I also think the first 3 months of the year could have a decent positive, upward bias as the economic data steadily improves and the peak inflation data highlights the worst is over for now. Thats called “disinflation” and its akin to the word “Goldilocks” as far as equities are concerned. I also thought the most speculative stocks with the highest beta and least amount of profits would be the group that bounced back the hardest. So far, that’s been correct. I still believe having a big overweight to the high quality style factor is the place to be for 2022, prefects, cash flows, higher margins, strong pricing power and industry leadership should perform better than most other style factors in 2022. At some point, we will want more defensive brands as growth peaks and slows on the margin but for now, the high quality growers have my attention. That cohort is always my favorite though, they allow me to sleep at night the best.

Friday 12/10-

Today’s CPI report showed annual inflation rising 6.8% to the highest level in nearly 40 years. 40 years folks. Here’s the good news, none of these distortions would have occurred where it not for Covid and more importantly our policy makers response to Covid. Yes, supply chains are still a mess, shipping costs are still high, wage pressure is a real and sustainable thing but we deal in rate of change terms and from my perch, unless the worlds leaders continue to open and close economies over and over causing massive and continuous disruption, everything but the wage pressure has likely already peaked or is soon to peak and the comparisons YOY will look much better next year and a heck of a lot better in 2023. To build a portfolio and have a mindset that anchors to the sustainable and high inflation across every sector and industry simply seems foolhardy. Time will tell but thats my view FWIW.

On market action in general, we still have the Fed next week and then we get into full holiday trading-mode which most of the time leads to a low volume levitation in stocks. The volatility should continue though because we have tax loss season and cap gains being taken on the assumption that rates will be even higher next year so what tends to work is what has already been working. If you are holding on to some laggards (I certainly am), if the story hasn’t changed and you still love the company, buy more while the calendar favors you getting the stock cheap. And if you don’t have any travel stocks, they are on mega-sale right now so take a look at some of those too, they are severely depressed and demand for travel has not eased one bit. I’m not talking airlines though, that is just a crappy business, I’m talking travel platforms like Expedia and Booking and Airbnb and even the major hotel operators. By my estimation, the VRBO unit trapped inside Expedia is worth more than the entire market cap of Expedia. I just sent the CEO/CFO and email with my thoughts, who knows if they even will see the email but seems to me, if you spin-off VRBO while still owning a majority stake, you unlock a ton of value in Expedia shares and you generate a lot of cash to assure you stay investment grade and taken even further, you can make Expedia the high dividend stock for income investors and VRBO becomes the focused home sharing growth stock similar too AirBnB.

I suspect we will have one heck of a January effect type rip higher in the stocks that have been destroyed the most. Tick tock, it could start at any time.

Week of November 29 Market Notes

Mr. Toads wild ride continues. With the VIX spiking from 19 on Nov 24 to a peak over 31 today (12/1), I think it’s fair to say there’s some fear and capitulation selling going on in markets. The media is telling us it’s the Omnicron variant but stock breadth was deteriorating well before anyone ever heard of the new variant. We have Fed tapering and maybe an acceleration of the taper, a seemingly less dovish Fed that has finally admitted to the world Inflation is not transitory (dah), the debt ceiling looming, a potential tax hikes creating a pull-forward of tax loss harvesting and gain recognition now versus 2022 all weighing on stocks and sentiment. I like buying fear so I’m fine watching VOL rip higher for now, those are mostly wonderful times to add risk to the portfolio. Remember the rule on the VIX: when the volatility index is up 40%+ in a week or less, you buy into that VOL spike unless the world is going into a very dark place, I do not see this now.

Washout signals are building up big-time as we see the markets dumping into the close today (Wednesday, December 1. The number of stocks in the S&P 500 and Nasdaq that are trading above the 10 day and 20 day moving average is under 10%. In fact, at the close Wednesday, just 5% of stocks in the S&P 500 were above the 10 day and only 9% were above the 20 day. The numbers were slightly better for the Nasdaq at 10% and 12% over the 10 & 20 day averages. The VIX term structure closed inverted meaning there was a scramble for near-term protection in the form of puts. We had 2 days in a row of +100% IVOL premiums highlighting the scramble and expectations for higher volatility near term versus 30-day realized VOL. A premium this high rarely happens and unless you see the obvious reason, it’s typically a sign to be aggressively buying dips in stocks. And likely the higher beta the better. Even in the face of all this, the volume on stock exchanges today (Wednesday) was much lighter than one would expect given the damage across most sectors and style factors lately. These data-points colliding together are very rare occurrences and most often signal a wonderful time to be aggressively buying your favorite stocks or brands. Here’s a great chart from Hightower that speaks to the opportunity when buying big bouts of fear & panic. BUY SOME STOCKS! ADD MORE ON ANY FURTHER DIPS says the fear and risk metrics I track.

Here’s a similar post from a great follow on Twitter @MacroCharts

With all this selling in stocks and high yield credit, the economy must be rolling over right? WRONG. Heres todays ISM, close to a high while the prices paid component slipped a bit highlighting that inflation may have already peaked on a rate of change basis. It should stay elevated for now but might not get any worse unless we have more politicians and policy makers closing borders and companies closing manufacturing lines again. If supply chains and manufacturing lines stay moving, the worst of the inflation scare is likely behind us. Reminder: wage inflation should prove more sticky so please be mindful of the stocks you buy and own to make sure they either have super high demand and/or very good pricing power, ideally you want stocks with both.

Demand for housing and home furnishings has not slowed at all.

Week of November 15 Market Notes

Week of November 8 Notes

Consumer sentiment has fallen hard, normally this happens when credit spreads are blowing out, this time its CPI going vertical, if prices stay high, demand WILL fall, consumers have $4T but they don't like getting fleeced.The brands that offers deals will gather that high demand. The brands that have high demand for their products and services and with high brand love have strong pricing power, everyone else will be fighting an uphill battle trying to keep sales and margins high as consumers begin voting with their $dollars. We are focused on the brands that have wicked pricing power and those that can gather market share because they can keep prices low while keeping margins stable. Scale matters more than ever right now.

A Summary of the Report

“Households are wealthy, flush with cash, and ready to spend—setting the stage for a lasting, self-reinforcing surge in demand.” Bridgewater Associates 10/19/21

•  In aggregate, U.S. households have >$4 trillion in consumption capacity.

•  For the first time in many decades, wages are rising & consumers have options.

• A historic inventory re-build cycle is upon us. This should keep prices & profits high.

• Consumers are already becoming selective about where they spend, higher prices everywhere drives more interest in the most high demand categories and to the most relevant brands serving these categories.

#1: Excess Savings - The Consumption Cushion Remains >$4 Trillion (Hedgeye Research)

Because of covid-lockdowns, fiscal and monetary stimulus payments and deferred spending by consumers all over the world, there is now more money reserved for future consumption capacity than ever before.  Human beings are a very predictable bunch. When we have excess savings, we save some, invest some, and spend some.  As dedicated investors in the global consumption thematic, I’m not sure we have a better set-up than we do today.  The global wealth effect has also never been more robust. Home values and equity in homes has never been higher, stock market wealth has never been higher, savings have never been higher. In addition, an estimated $30+ trillion is just beginning to pass from older Americans (baby boomers and the silent generation) to their Gen-X and Millennial children. 

And we can’t forget about our best corporations. They are flush with $2 trillion in cash on the balance sheets currently which Goldman predicts will be $3.1 trillion by the end of 2022.  All of this cash offers an enormous buffer for the inevitable clouds that will emerge in the future. 

There will be continued buybacks, massive cap-ex cycles, R&D spending, dividend increases and a continuation of strong M&A trends. In fact, if politicians decide to tax buybacks, more money will likely flow to M&A than ever before. Money will always flow to the places where the best returns are possible. Fun fact, M&A deal value YTD by U.S. firms is already over $1.1 trillion, the highest level on record. We expect it to continue and have invested in a handful of the primary beneficiaries. These brands are still cheap, have fortress balance sheets, and are incredibly well positioned for what’s to come.

#2: Wages Are Rising For the First Time in Decades

Consumers Have Never Had So Much Leverage To Negotiate Higher Wages

Getting paid a higher living wage is a very positive development for consumer sentiment which ultimately drives purchase intent. Consumer services continues to be the portion of the economy with the most potential for mean reversion back to normal but total consumption should be broad-based given how large the savings excess currently is. A bonus: higher wages for lower income consumers tends to get spent more quickly which adds to the consumption component of GDP and the revenue lines of the most relevant brands serving this cohort.

#3: Today’s Supply Constraints = Tomorrow’s GDP Amplifier (Hedgeye Heading)

A Historic Inventory Re-Build Cycle Is Just Beginning

Black line: ISM Backlogs (Mfg + Services, GDP Weighted)…Grey Line: Inventories, Contribution to GDP

These metrics tend to move together but currently, there’s a massive delta that will eventually normalize in favor of a large inventory re-stocking. This will take time because supply chains are still jammed and consumer demand is robust.

There’s been a lot of talk about the shipping delays, port delays, lack of trucking capacity and the rapid rise of prices because of these bottlenecks. Over time, these headwinds will normalize but it will take time as epic demand collides with a continued slower than expected production of goods. Because of these delays, inventories across most industries are rapidly being drawn down. For most products, there will be no discounts for the holidays, bad news for consumers, great news for corporate margins and revenues. Remember, revenue and cash flow feed directly into corporate earnings and these factors ultimately drive stock prices. For the most relevant brands, the consumer is a gift that keeps on giving.

Inventory rebuilding and better job gains should allow GDP to stay “above trend” versus what we saw between 2009-2020. Again, the Covid normalization process will take time and the re-boot process has created some wild distortions. Just remember, there can be no better hedge to our spending, then the potential capital gains we can generate from investing in the brands we know, trust and love. Embrace this epic consumption opportunity, it has a very long tail.

SUMMARY:

• Consumers have a record amount of cash that can be used for future consumption.

• Consumers have significant leverage for higher wages which flows to higher spending.

• A historic inventory rebuild cycle should allow GDP to levitate above-trend. 

• Stability of earnings and strong pricing power ultimately flow through to better earnings and higher stock prices. For now, consumption nirvana is the diagnosis.

Week of November 1 Notes

11/3 - Fed day. The Fed announced the taper of bond purchases will begin this month with $15B and they will also taper in December. Some think the December announcement is slightly hawkish but I think the market just likes certainty so I’m happy they told us December would be the same. As always, they said they will adjust their tapering as needed by the economic data. This is why I laugh when everyone focuses so closely on every word by the Fed. Jerome has been very clear since his whiff in Q4 2018 when he kept raising rates into a clear economic slowdown. His actions are data dependent. Period. He stated the slowdown created by Delta variant has kept the economy below potential and implied what we have been saying all along: we would not be having labor issues, supply chain problems and wage inflation were it not for Covid, therefore as supply chains get cleared up(it still takes time) and hiring picks up, much of the inflation that’s been created should start to ease. Companies will absolutely try and hold onto the price increases they have enacted but I suspect they will be quick to lower prices where they can if demand starts to fall. That’s certainly why I’m focused on the most in-demand brands and spending categories as consumers begin to make choices about where they spend. The wage hikes will be sticky and companies that are not leaders in their peer group and that don’t have high demand and pricing power will start to see margin erosion. Asset light businesses should be better positioned than capital-heavy, labor heavy businesses. I suspect that will be a key theme for 2022 earnings. Second and third tier companies are NOT where you want to be next year, they likely do not have the ability to keep margins and sales high in the face of high labor costs and demand that may slow. Inflation pressures overall should peak on a ROC basis as these issues subside and go back to normal.

Most important part: there was NO mention of fed rate hikes on the horizon which should put that issue on the back-burner for now. The Fed wants to see hiring get back to normal levels first. Getting back towards full employment and a stabilization of earnings and overall growth should allow them to start thinking about small rate hikes but I see no evidence that meaningful rate hikes will happen in 2022. This economy, with its debt and demographics has been running at sub-par trend growth since 2009 and I see nothing that changes that. The one caveat will be added productivity created because of all the belt-tightening in corporate America from Covid. Technology allows companies to do more with less so there’s always a chance productivity enhancements will allow for sustained strong financial metrics in the face of higher labor costs. Having lots of slack in the labor force should keep a lid on rates and inflation though. Earnings & financial metrics could stay strong because of tough decisions made in the beginning of Covid. Companies get hooked on better financial metrics and stock prices so they will be slow to slip back into their inefficient ways going forward. The business efficiencies that were created in Covid should prove to be long-lasting.

Bottom line: For now, I think we have a goldilocks economic scenario where growth is trending in the right direction as inflation pressures subside. That’s a pretty good environment for equities. Below is a list of the data-points we got so far this week, courtesy of Hedgeye as well as some of the data that has very strong mean reversion possibilities. Growth is real even in the face of bottlenecks and wicked wage pressure.

• ISM Services PMI report on Wednesday, which advanced 4.8% percentage points in October to an all-time high of 66.7%

• The Bureau of Labor Statistics reported that nonfarm payroll employment increased by 531,000 in October, a strong print versus the 450,000 consensus. Additionally, the unemployment rate ticked down 0.2% monthly to 4.6% in October, slightly better than the 4.7% expected. The labor force participation rate came in 61.6%, unchanged from the month prior and a tick lower than the 61.7% consensus. Average hourly earnings for all employees came in a $30.96, representing a 4.9% increase versus the year ago period, in line with expectations.

Current portfolio and positioning into 2022 from a client question.

The economy looks set to re-accelerate after softness related to inflation and supply chain delays – growth should accelerate back to “trend” at least for a quarter or two

• Many of the inflation metrics I follow appear to have peaked, but I think some forms of higher prices will stay elevated for a bit – wage inflation could be the stickiest

• We have lowered our exposure to some of the services sector names where high labor costs keep their margin profile trending lower. Our focus is high demand industries that can pass those costs on to the consumer. Position in Chipotle, Caesars and Live Nation come to mind.

• I think we will have a M&A boom, particularly if they decide to tax buybacks. Money flows where opportunities are so I love my positions in BX, KKR, GS, MS. BX-KKR are raising oodles of capital and its long-term and higher fee. Plus we are likely in inning 1 of the global exodus out of interest rate sensitive fixed income. Even if rates don’t rip from here, the traditional bond mix will likely be 2-3x more volatile than the last 30 years and offer half the total return at a time when older people need those returns and stability. Massive wave of capital will flow to alternatives, private equity and VC, real estate hard assets. The indexes thrive on volume so I love Nasdaq position here. Its super cheap and grows well.

• We will update our Brands 200 Index next month so I’ll get access to a host of new brands to consider. I’m liking the Warby Parker (eye retail) and Rivian a lot. Rivian is going to be a monster. Amazon owns 20% of the company. I love the process of updating the investment universe, theres always some names I get access to that I don’t have currently.

• RH is still the top holding and I add to it every time I get the chance – they are building THE global brand for luxury home furnishings, that market is so fragmented but a mega brand will take so much share. I have a $2000+ target and its just under $700.

• We still love the Amazon, Google, Apple, Netflix positions – Amazon has been disappointing and the biggest drag will be their labor costs but this spending cycle for them is historic so that should lead to a good 2022 if history is a guide. The stable, predictable growers with stellar balance sheets are a staple of the portfolio.

• I worry a bit about overall consumption trends if consumers keep getting squeezed from every angle. We are positioning for the inevitable consumer thought process of: “everything is expensive, my income isn’t going up enough to account for this squeeze so I have to decide what brands I love and need and which ones I defer my purchases on”. So we have moved up in brand relevancy so we own THE 800 lb gorilla in a spending category we like.

• All in all, we have a good mix of re-opening brands that should have better 2022 than 2020-2021, a great allocation to the secular winners of e-commerce, digitization of everything, physical retail favorites and winners of themes like M&A, money flows to alternatives. I still love the fintech payments category and they are now on sale, still not “cheap” but definitely on sale.

• A key area of recovery is the return of cross-border, card present travel – Visa has been a big laggard but I think the payment providers will get back to robust spending trends globally and benefit from a bit of inflation that helps their transaction volume be higher.

• I suspect at some point next year when we start to see if the economic data looks to be slowing again we will add some defensive brands in consumer staples and healthcare while being willing to hold some cash.

October 2021: Market Observations

October is in the books and a pretty good month it was. Here’s the summary:

Top performer - the consumer - XLY Consumer Discretionary ETF +10.2% - largely on the back of a massive rip in Tesla +43% (19% weight in the ETF) as they join the $1 trillion club.

QQQ +7.4%. SPY+7%. IWM: +3.84%. VIX: -29%. TLT: +2.7%

IWO (Small Growth): +4.7%. IWN (Small Value): +3.8%

IWP (Mid Growth): +7%. IWS (Mid Value): +5.3%

IWF (Large Growth): +8.7%. IWD (Large Value): +5.1%

Sectors:

XLP: +3.5%

XLK: +8.1%

XLI: +6.8%

XLE: +10.3%

XLF: +7.2%

XLC: +0.24%

VNQ: +7.1%

XLB: +7.6%

XLU: +4.7%

Thoughts:

Covid-fatigue continues around the world. As cases flare-up in China, the UK, etc, the impact seems to be getting less attention. Humans are wonderful adaptive creatures, hit us in the face 10 times a day and over months, each slap just doesn’t have the same effect. Evidence?

1. Cross-border travel continues to improve and appears to be back to 2019 peaks and this is just the beginning of the cross-border travel recovery. There is MASSIVE pent-up demand to travel out of one’s home country and I do not see this demand peaking anytime soon. There will be bumps along the way but the trend seems clear - consumers like to move around and the longer they are kept from moving, the more they want to move.

Beneficiaries: Visa, Mastercard, American Express, Delta & United Airlines, Expedia, Booking, Airbnb, Marriot, Hyatt, Hilton to name a few. Uber & Lyft should also benefit most Uber in particular still appears to be a hot mess chasing yesterdays cheese versus picking a lane and dominating that business.

2. Paypal & Pinterest potential acquisition was denied by PayPal. For now PYPL is a show-me stock and needs to prove their growth trends are still in-tact. If they are, the earnings on November 8 could serve as a fresh, sigh of relief catalyst to re-rate the stock higher. There’s no doubt that PayPal needs to build the components of its proposed “super-app”, I suspect it will make a big acquisition or do a JV sooner than later. The fact that they said “not pursuing an acquisition of Pinterest “AT THIS TIME”, tells me and the street there’s something looming.

3. The cyclicals rally has been strong but has been a “fits-and-starts” process. THere’s so many macro details driving these short-term movements but based on this GS chart below, this is NOT early days which makes me feel even better about having my toes in both the cyclicals and recovery names PLUS the secular growth brands serving global consumers.

4. Very interesting chart from Liz Ann Sonders at Schwab showing a relative price chart comparing Leading Economic Indicators (LEI) with Coincident Economic Indicators (CEI). When the line is rising, the economy and indicators are expanding, a positive thing. What’s interesting here, is this line has broken a downtrend that’s been in place since 1972 or 1978 depending on how you do your chart work. Like I have said many times, there have been so many distortions created from Covid that some of the data, when at extremes (good or bad) is often simply a mean reversion from an extreme condition. Bottom line here: the leading economic indicators appear to be the dominant trend signal which is a positive until we see some signs of deterioration.

Top Five Leading Economic Indicators (the balance.com):

1. The yield curve - The yield curve shows the return on short-term Treasury bills compared to long-term Treasury notes and bonds. In a normal yield curve, returns on short-term notes will be lower than the longer-term bonds. Investors need a higher yield to invest their money for longer. We do not want the curve to invert, those hint at possible recessions on the horizon. Currently: POSITIVE.

2. Orders for Durable Goods - The Durable Good Report tells you when companies order new big-ticket items. Examples are machinery, automobiles, and commercial jets. This isn't the same as consumer purchases of durable goods, such as washing machines and new cars. That's important, but business orders change before the business cycle changes. Currently: POSITIVE.

3. The stock market - we know the market looks forward so when the market is in an overall positive bullish trend, the implication is the economic situation across businesses and consumers is positive. I would also add home price appreciation to get a more complete “wealth effect” reading. Currently: POSITIVE.

4. Manufacturing jobs - if businesses feel positive about their demand profile, they will spend on “cap-ex”. Companies do not take that decision lightly. When factory orders rise, companies need more workers. That benefits other industries like transportation, retail, and administration. When manufacturers stop hiring, it means a recession is on its way. Right now, there’s a worker shortage and wage increases are everywhere. Currently: POSITIVE.

5. Building Permits - Shows evidence of new home construction trends nine months from now. Most cities issue the permit two to three months after the buyer signs the new home sale contract. That's six to nine months before builders complete the new home. Simply shows if demand and confidence is high enough to warrant people making a major purchase or not. Currently: POSITIVE.

Coincident Economic Indicators are things like: Payroll employment data, household income, industrial production, current business revenues.

5. Tesla hits $1 trillion market cap club! On of my favorite brands is the next to reach the $1T club. The company is the first brand you think of when you consider buying an EV. It’s probably the second and third brand you think of too. The company and Elon Musk have a cult following and the stock has been digesting last years move for most of this year until recently. To me, the stock is showing signs of upside capitulation on a short-term basis. Not a bad time for Elon and the company to sell some stock imo. If I was the CFO of Tesla I would be pounding the table on doing a $20+ billion secondary and selling some stock, paying down some debt and padding my balance sheet for future production costs.

6. Stock buybacks are still an enormous source of the potential upside energy in the stock market. Corporations and employees are restricted to trading during certain periods. Here’s a great chart showing we are now headed to the favorable part of the buyback window. This could certainly help to absorb any of the selling that occurs for any other reasons.

7. Just a reminder that the market has already had a decent correction even if the indexes haven’t felt it the way the average stock has. I understand people’s nervousness about a market at all-time highs into a period where the Fed will begin tapering, inflation is high and likely sustainable but there’s plenty of opportunity stocks currently still on sale.

10/22/21: The earnings fireworks have just begun

When something like inflation or stagflation appears, it starts to eat into overall corporate profits one industry and company at a time. It’s a slow moving train because each business is unique in its own way. Some businesses are better at managing through good and bad times and some have superior pricing power, better control of the supply chain inventory, and very high-demand across their products & services suite. There’s been so many distortions created from Covid across supply chains, with labor shortages and virtually every company has experienced higher input costs that they are passing through to the end users. If the U.S. consumer, in aggregate weren’t so healthy from a balance sheet and credit perspective, this nasty bit of inflation across virtually everything we want and need to buy would be more of a problem for consumers and corporations than it is currently. But make no mistake, the strong versus the weak are now being highlighted in earnings reports. Plenty of companies will try and mask the weakness in their businesses using the supply chain issues, labor shortages and inflationary pressures but the reality: the number of companies (brands) that have products and services that are in such high demand to allow them plenty of pricing power is fewer than most think. This period is an ideal time to be investing in industry leading brands serving high demand industries.

2022 prediction: indexes will not perform as well as active stock pickers who have the ability to be highly concentrated and flexible. Yes, I’m talking my book but I have the luxury of not being style-stubborn or being forced to be fully invested at all times. If/when me & the team get more bearish, we have shown a willingness to hold a bunch of cash and swap some offense for defensive brands. Overall, the opinion of a manager with few options to adapt is less valuable than one who has flexibility. Sorry for getting off-topic. When businesses and consumers start to become selective about what price increases they are willing to absorb and which one’s force them to decide to go elsewhere, fewer and fewer companies will meet or exceed current estimates. I suspect we need to see estimates come down for at least half of the companies in the S&P 500 for 2022, particularly if this situation persists much longer. Stock picking has never been more important in my opinion.

This week:

Overall, market’s did pretty well this week but there was a clear bias for mid-caps in general and mostly value over growth. The winner on the week was Mid-cap value + 1.66% on the week. The laggard was the Nasdaq QQQ +.37%. If you’re a ridiculously expensive stock like SNAP and you lower the boom on earnings and guidance, growth & momentum investors tend to leave all at once and leave skid marks. Today, SNAP stock was down about 25% and it’s STILL absurdly expensive. It can bounce on oversold but you couldn’t pay me to own this company. They still can’t make any money and they don’t really sell any products. What a world!

Interest rates: the 10 year treasury yield rose 65bps this week or 4% on the week. High valuation growth stocks continue to lag Garp (growth at a reasonable price), core and value stocks. This theme has largely been in place since February. With the potential for economic growth to re-accelerate after slowing for the last few months due to delta-variance issues, rates could move further towards the 1.85% zone again. Under that scenario, the expensive growth style factor could lag value stocks for a bit longer. Scrolling through my Twitter feed, there’s definitely no interest in value stocks and everyone continues to be fully anchored to their super expensive “compounder” stocks. I have significantly shifted the Brands portfolio towards the GARP and Core baskets and have reduced the exposure to the most expensive portion of the market. Those decisions have served us well thus far in 2021. I still have some exposure but these are smaller weights and very idiosyncratic stories.

Next week tends to be seasonally weak for some reason. Plus we have an overbought market in need of a rest. Plus we have big tech earnings but with a negative bias, this might be a decent set-up for upside surprises. The wild ride continues.

Here’s a great chart from Hedgeye highlighting the potential trajectory for GDP into next year. We are a week away from strong and positive seasonality in markets plus a likely inflection of better economic data led by jobless claims falling further and hiring accelerating. This should keep rates elevated and stock markets well-bid until we start worrying about the next debt ceiling showdown. My gosh are politicians worthless. I suspect I’ll be adding more defensive brands sometime later this year or earlier in Q1 next year. I’ll let the data and the charts tell me when/if to pivot.

Slowly but surely, people are going back to work and unemployment claims are falling. That’s highly supportive of consumption trends staying positive.

Hedgeye: Covid cases lower=hiring & confidence rises + adds more services sector activity = income accelerates = consumption capacity rises = Consumer Discretionary and other sectors tend to perform well.

10/16/21: The Consumer is Very Resilient & has $2.3 trillion in excess savings STILL

Consumers, as a general rule, are very predictable. When we have extra money, we spend some and save some. A portfolio of the brands we love to spend our time and money on as well as those that benefit when we save & invest, makes a wonderful CORE.

What ultimately drives stock prices higher? strong earnings & revenue growth.

What causes strong earnings & revenue growth for consumer companies? Consumer spending, particularly when we have an epic amount of excess savings to the tunes of >$2.3 trillion.

Currently, the amount of money in U.S. money markets is about 20% of GDP or over $4 trillion. Some of that money can trickle into the equity, bond and alternatives markets but households already own a historic amount of these assets. In fact, per a Morgan Stanley report, U.S. household wealth (homes, stocks, bonds, businesses, etc) accounts for ~590% of GDP or about 170% HIGHER than the 30 year average. Part of this is demographics but in general, we have what we need from an assets perspective. The more likely use of excess savings is a slow trickle into the goods and services we all want and need. That feeds into better earnings and revenues for the most relevant companies. This higher EPS and revenue growth is ultimately what will drives the stocks of these great brands higher. The market can do whatever it wants day to day but the future of this $2+ trillion is not in question: it will trickle into the economy and flow through to stock prices. That’s why I’m so excited about the Brands portfolio and the consumption thematic today.

Market Notes:

The ports may be over-loaded but demand is still strong. When too much money chases too few goods, prices rise. It’s simple economics. The question we all want answered: how long will high prices last? That’s likely the key to an economy that keeps growing or one that ultimately suffers from a fall in demand. Biden is finally working with all parties involved to get our ports running 24/7 so we can reduce this historic backlog of ships waiting to unload merchandise. Prepare to begin your holiday shopping today because inventory levels across most industries could be low as we head into the end of the year. I suspect though, things are about as bad as they can get and the inventory replenishment cycle is not far from commencing once these bottle-necks get resolved. Make no mistake, demand for goods and services is high. As Covid slowly transforms from pandemic to endemic, and vaccinations become widespread, global workers and the manufacturing supply chains will also trend back to normal. As we draw down inventories across most categories, these supply lines will be very busy replenishing inventory in 2022.

The death of consumerism has again been greatly exaggerated. The world has been under-estimating a consumers propensity to spend for about 50 years now. They have also largely ignored owning many of the most relevant brands serving consumers from a stock perspective. Intuitively, we all know this is a consumer economy but we forget to connect the dots back to our investment portfolio’s. There is no better hedge to the spending we all do than to own many of the great brands we love and spend our money on. My grandfather used to say, “if you don’t like the prices at the pump, buy the energy stocks and get some of that money back from cap gains”. Let’s look at a real-world example via one of my wife and daughter’s favorite brand, Lululemon, LULU.

If you bought LULU stock 3 years ago and spent $10,000 you could have bought 67 shares.

The same $10,000 in the S&P 500 ETF, SPY would get you 38 shares.

As of Friday’s close, my rough math shows the S&P 500 investment would be worth $16,943, not bad.

Investing your $10k in LULU, a brand you love and spend your money on would be worth $27,035.

The difference between the S&P Index return and the LULU return is about $10,092 or about $280 a month for 3 years in extra gains. Congratulations, go buy those new leggings you have been eyeing!

What’s the moral of the story? Not only can you make more money investing in what you know and love, you can also get some extra spending power for merchandise from the gains in addition to what you could get from an index investment where you have no idea what you own. That’s powerful and often overlooked by investors.

Economic data:

Friday’s Retail Sales Report for September was better than expected. Yes, because of stimulus payments and other fiscal support, consumers have more cash in their checking accounts than ever before. Add epic home price appreciation and a stock market close to all-time highs and you have quite the formula for a consumption capacity expansion. Not to mention, the buy-now-pay-later (BNPL) business line is allowing consumers the ability to take the edge off high prices by spreading out consumption for a few extra months. Do not under-estimate the effect of BNPL on overall consumption. This thematic is just getting started. I don’t know how these businesses will fare in a recession but that’s not where we are today.

There’s still $2.5 trillion in savings that need to be drawn down slowly over time. The sheer size of this wall of money makes the consumption thematic likely the most predictable for the next few years. Consumers are finally making a little extra money, already have some extra cash in their pockets and are feeling better about Covid and its affect on our daily lives. As a counter-balance, the price of everything we want and need continues to rise making us feel squeezed. Even if we have cash in our pockets, we still don’t like overpaying for everything. Frankly, it makes us feel a bit ornery towards the brands we spend money on but thus far, higher prices doesn’t seem to be affecting consumption. If price increases continue though, it will ultimately drive behavior change. I suspect we are now in the “this versus that” phase of consumption. When you get squeezed from every direction, you start to make choices about what is worth the spend and what gets deferred. Second and third tier brands are already feeling that pinch. Just ask Bed Bath & Beyond. If you’re a brand without differentiation and most people wouldn’t even know you went out of business, this is not the environment for you. If you’re a high demand, high brand love company that sells a high demand product or service, you have pricing power and you’re likely crushing it right now. LVMH just told us demand for luxury goods is very very robust, even in China where people were most worried. As an investor, those are the brands I want to own at this part of the business cycle.

Current Market Outlook

2021 continues to be the wackiest market I have ever seen. So many distortions were created because of Covid. The economy fell off a cliff, the Fed and politicians dropped cash from the sky’s, big pharma created “vaccines” to help calm nerves and the economy came ripping back even while looking a bit different than before Covid. So many growth companies pulled forward 3-5 years of revenues and their market caps reflect this windfall currently. Most are very expensive and still have difficult comps given their historic revenue pull-forwards. Plus, they are long-duration assets and therefore more sensitive to rising rates. These stocks have been very volatile since February and have lagged traditional value and cyclical stocks as we transition from early cycle to mid-cycle. Investors now have to make a choice: continue to overweight expensive stocks with good growth characteristics and excessive valuations or invest in companies that have struggled the last few years but seem to be on the right path for much better times ahead. In the Brands strategy, we have exposure to both baskets of stocks but we are much more intrigued by the brands with good recovery prospects versus the Covid-beneficiaries with nose bleed valuations. Again, we are exposed to both type of stocks but are currently much more over-weight brands that should have much better year-over-year recoveries in 2022.

Technically, the market appears to be on much firmer ground after a rolling correction that took most stocks down at least 10%. We are still in market repair mode but with an extension of the debt-crisis and rates that are not running away from us, it feels like the path of least resistence is higher until we have to start worrying again about politicians not doing their jobs yet again.

Consumer Financial Health Has Never Been Better - That bodes well for future consumption capacity