The Weekend Edition # 27
Does a Market Bottom Matter?; The Hiking Cycle; Earnings - Banks, Transportation, Airlines, Consumer Staples and Mining
Welcome to another issue of the Weekend Edition.
Thank you to all who’ve read and subscribed to the newsletter this week!
This week we cover:
Macro of the Week - The Hiking Cycle
Earnings - Banks [GS & MS], Consumer Staples [PG], Transportation [UNP & JBHT], Airlines [UAL & AAL] & Mining [AA]
The Week Ahead - Event Calendar
Closing Thoughts - Does a Market Bottom Matter?
Let’s dive in ⬇️
Market Recap - Jan 18 - Jan 21, 2022
For a shorter trading week, we sure had a brutal drawdown in the market, and earnings season isn’t really helping this time. We also had OpEx expiry on Friday which rattled the market even further.
As a reminder, 10% down is a pull back, 10-20% down is a correction, over 20% is a bear market.
All broad market indices have now crossed below their 200-day moving averages.
The Russell 2000 small cap index is very close to approaching a bear market, with the Nasdaq Composite and the Nasdaq 100 in correction territory.
We have big tech reporting next week and the week after - this will be very crucial to watch, along with the FOMC rate announcement and press conference on Wednesday.
The Vix is now at 28.85 and firmly above it’s 10-day and 50-day moving averages. There’s some consensus that this can signal a market bottom but, I wouldn’t be so sure just yet. Furthermore, the 3-month Vix is lower than the current Vix which also signals a market bottom.
Markets are now oversold based on technical indicators and many can take this to mean a reversal. You know what? Markets have been known to stay oversold for a while and there’s nothing that says that the Vix and all other indicators cannot break norms. I don’t think we know anything until we see a proper trend reversal.
The AAII Sentiment Survey shows that the market is the most bearish it has been in the last 16 months. The Sentiment Survey is more of a retail indicator where AAII members can vote on their take of the market.
Finally, the sector rotations show the market is firmly in defensive mode. With Utilities and Consumer Staples (the boring stocks) leading the week.
Speaking of sector rotations, Energy has been dethroned. This week we saw WTI Crude hit an 8-year high at $87.10/bbl and then promptly head back down on news of US stock piles. The market is still looking bullish for oil long-term as we are still not back to pre-pandemic levels of demand and supply is still not where we need it to be.
Macro of the Week - The Hiking Cycle
This is just in from Bloomberg. According to Bloomberg, the S&P 500 doesn’t do so poorly after a rate hike cycle. In fact, according to them the market still returns an average of 9%, according to their data since the 1950s. While this may be the case, let’s look at their two charts here:
In the first chart, they take the average annualized return over multi-year periods that have experienced 12 rate hike cycles. This shows quite the positive picture that rate hikes don’t necessarily mean that the stock market fails.
However, the second chart above on the right shows that during these rate hike cycles, there tends to be significant volatility in the market. If you look at 2018, it shows the drawdown in black to be quite significant - almost a 20% correction.
But concentrate on the pink bars above. This shows the return in the markets after a Fed hiking cycle, and for a few years including 2018, the annual return did turn negative.
Why is that so? Increasing rates, particularly to combat inflation can be healthy to a certain extent. The problem starts when the hiking cycle gets too intense. Multiple aggressive rate hikes coupled with Quantitative Tightening can send the market into a tailspin, as it did in 2018. If you remember, I’d mentioned this in my year-end newsletter. It had taken 8 rate hikes before the market went into a down trend.
Here’s a clearer chart for emphasis ⬇️
Earnings of the Week
After back-to-back bumper earnings season, we’re definitely seeing signs of a slowdown. Even with earnings beats the price action has been negative for many companies either because of lower forward guidance (Netflix) or because their still facing supply chain issues (JB Hunt).
Banks - Goldman Sachs (GS) & Morgan Stanley (MS)
Most of the remaining big banks reported this week - Goldman Sachs (GS), Morgan Stanley (MS), Bank of America (BAC). As you can see, GS missed on revenue while MS and BAC missed on earnings.
GS reported revenues down 7% YoY in their global markets business with the equity side down 11%. They also reported higher compensation expenses just like JPM.
MS on the hand reported better than expected results in their equity division. But, fixed income was still down 31%. E*Trade’s first revenues were reported this quarter, quite possibly leading to the 10% growth in their Wealth Management division.
Consumer Staples - Proctor & Gamble (PG)
Pricing power! That’s the word for P&G’s solid quarter despite inflationary headwinds. The Company expects $2.6B of higher commodity and freight costs in FY22, up from $2.3B estimated during their Sep quarter. Nevertheless, the P&G raised their revenue guidance slightly by 1%. Their products are staples and this has allowed them to raise prices without causing much disruption to results. The Company has a solid 2.1% dividend yield and a share repurchase program of ~$9B.
Transportation - Union Pacific (UNP) & JB Hunt (JBHT)
Both beats, no surprise there. And what’s more interesting is that both had similar issues - intermodal.
UNP reported a decrease of 14% YoY in their intermodal and vehicle parts business while JBHT explained their delays in sourcing machinery.
Average revenue per car was up 11.5% YoY for UNP while revenue per load for JBHT was up 26% YoY.
Supply chain issues are cutting both ways for transportation companies - increasing revenue per load but decreasing volumes & higher labor costs.
The transportation index fell quite a bit this week but, I still see growth for these companies as supply chain congestions get better.
Airlines - United Airlines (UAL) & American Airlines (AAL)
Airlines continue to struggle despite EPS beats.
Both issued downside guidance for Q1, 2022 as Omicron continues to be a problem - AAL guided down 20% to 22% vs. Q1, 2019 and UAL guided down 20% to 25% vs. Q1, 2019
Costs are also on the rise - both fuel and labor
Domestic travel seems to have bounced back but business and international still remain significantly below 2019 levels.
Mining - Alcoa (AA)
Alcoa delivered a fantastic quarter backed by aluminum prices that have increased almost 50% YoY.
Revenue increased 38% YoY and they’re still guiding higher for the next quarter.
Global aluminum inventory still remains at historically low levels as China has cut back production to curb emissions.
Demand on the other hand remains elevated because of the strong housing market and gradual resumption in infrastructure projects.
I think we will see more industrials do well in the coming few months as well as projects that were put on hold start to take off again.
The Week Ahead
Economic Data - The FOMC Announcement is on Wednesday
Wed Jan 26, 2022 - FOMC; Retail and Wholesale Inventories; New Home Sales; EIA Crude Oil Inventories
Thu Jan 27, 2022 - GDP; Unemployment Claims; Pending Home Sales
Fri Jan 28, 2022 - Personal Spending, Personal Income and PCE (more inflation indicators)
Many of the heavy hitters report this week, including 6 of the top 20 market cap companies on the S&P 500. You know this could cause volatility in the market so be careful.
A number of industrials and oil companies will also be reporting, and this could be interesting because these defensive sectors seem to be in favor at the moment.
Closing Thoughts - Does a Market Bottom Matter?
We still have too many events ahead of us to call a market bottom. Nor should we be looking for a market crash. I’m not trying to play both sides. It’s just that the signals are mixed right now and there are too many factors influencing the market to make a decision.
I suspect we see sporadic relief rallies, which could be influenced by earnings season and optimism in economic data but, until the market starts to reverse trend to the upside, I’d be careful.
We’ve been in a bull market for a while and with every price dip, stocks start to look cheap and tempting. But that’s because we’ve gotten used to seeing some outrageous prices.
But does catching the market bottom really matter in investing? I say, no.
There will always be opportunities to buy companies at great prices. Did you think you’d see Netflix below $400 again? I certainly did not! But, that’s no reason to jump into new positions just yet as the market could go lower.
Sure, you could average down into a long term position but, that still means you’re average cost is higher and in the meantime you’ll be flooded with a red portfolio, which is painful no matter what kind of investor you are.
I will be using this time to look into companies for sector rotations in the intermediate term and picking solid companies for the long term.
Here’s wishing you a happy weekend and safe investing.
Ayesha Tariq, CFA
There’s always a story behind the numbers
None of the above is Investment Advice and all views are personal. I may or may not have positions in any of the stocks mentioned. I have a position in $UNH, $MS, and $BAC. I have no affiliation with any of the companies that are mentioned.