Remarks:
-I have a new channel on Youtube where I share my latest thoughts on markets and investing. You can view the most recent video here.
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Charts and charts from the past week that tell an interesting story about markets and investing…
1) Stairway to recession
As expected, the Fed raised rates another 0.75% last week to a new range of 3.75-4.00%. This was the 4th consecutive increase of 0.75% and the 6th rate hike of the year. The current federal funds rate is now at its highest level since January 2008.
What happens next?
More hikes, but with increasing chances of a lower increase. Powell alluded to this at the FOMC press conference, saying a slower pace “could come as soon as the next meeting or the one after.”
Market participants are now pricing this in, expecting a 50bps hike in December (to 4.25-4.50%) and 25bps in February next year (to 4. 50-4.75%). After that, another 25 basis point hike is expected in March 2023, bringing the fed funds rate to 4.75-5.00%.
From there, markets are currently pricing in a pause followed by a new cycle of rate cuts starting in November 2023.
What would cause the Fed to stop climbing and move in the opposite direction?
a) Inflation is moving considerably lower.
b) The economy showing further signs of weakness.
2) Go in the right direction
On the first point, the inflation rate in the United States fell in October for the 4th consecutive month. At 7.7%, it was the lowest year-over-year increase we have seen since January.
Most important, as far as Fed policy is concerned, was the slowdown in the growth rate at the core level (excluding food/energy), which increased by 6.3% against an estimated increase of 6.6% .
Much of the rise in core inflation continues to be the all-important “Shelter” component, which rose to 6.9% in October. This is the largest increase we have seen in this category since 1982.
But CPI Shelter continues to be a lagging indicator as real-time housing data moves in the opposite direction…
a) Rents increased 5.8% year-over-year, the lowest rate of increase since May 2021.
b) Home prices rose 3.2% year-over-year, their slowest rate of growth since the start of the pandemic.
At some point, the housing CPI will start to reflect this new data, but we don’t seem to be there yet. There remains a sizable gap between reported and actual housing inflation that will likely be filled in part by continued increases in the housing CPI.
3) Why the Fed will continue to rise
Although there is growing pressure on the Fed to change course, Powell does not seem to agree with this line of thinking, emphatically stating that “the historical record strongly cautions against premature easing politics” and that they will “stay the course until the job is done.”
How will we know when the job is done?
An important benchmark will be when wages again outpace inflation, which we haven’t seen in 19 consecutive months (a record). This is a drop in prosperity for the American worker (erosion of purchasing power) and this is the main reason why the Fed will continue to raise rates.
4) The monetary policy lag
The full impact of this year’s rate hikes has yet to be seen, as there is a notorious lag between monetary policy actions and their impact on the real economy.
The labor market still seems tight (4.7 million more job vacancies than unemployed) and employment rose in October for the 22nd consecutive month.
Although the unemployment rate reached 3.7%, it remains very low on a historical basis.
But as the economy slows as we approach 2023, we should expect to see that number grow, and in the tech sector, we are already seeing a sea change in the landscape.
A summary of some of the layoffs this year…
- Twitter: cut 50% of its workforce (estimated 3,700 jobs).
- Facebook ($META): cut 13% of its workforce (11,000 jobs), the largest series of layoffs ever.
- Snap ($SNAP): cut 20% of its workforce (1,200 jobs).
- Shopify ($SHOP): cut 10% of its workforce (1,000 jobs).
- Netflix ($NFLX): cut 450 jobs in two rounds of layoffs.
- Microsoft ($MSFT): <1% headcount cut (1,000 jobs).
- Salesforce ($CRM): cut 1,000 jobs.
- Robinhood ($HOOD): cut 31% of its workforce.
- Tesla ($TSLA): cut 10% of its salaried workforce.
- Lyft ($LYFT): cut 13% of its workforce (700 jobs).
- Redfin ($RDFN): cut 13% of its workforce.
- Coinbase ($COIN): cut 18% of its workforce (1,100 jobs).
- Stripe: cut 14% of its workforce (1,000 jobs).
In addition to these cuts, Amazon ($AMZN) announced a hiring freeze, Apple ($AAPL) suspended nearly all hiring, and Google ($GOOGL) cut new hires by 50%.
5) Increased cost of money
With inflation outpacing wage growth, the U.S. consumer has resorted to saving less (lowest savings rate since 2008) and borrowing more (credit balances are growing at the fastest rate since 2011 ) in order to maintain its expenses.
And the interest rate on that credit card debt rose to 16.27%, the highest rate on record (note: data goes back to 1994).
The rise in the federal funds rate is also having a direct impact on the cost of adjustable rate mortgages, which are now above 6% for the first time since 2008. It was only last year that they reached a historic low of 2.37%. .
At the federal government level, rising rates lead to a rapid increase in interest expense on the public debt. At $747 billion over the past year, that’s a record high, and at the current rate, it will soon be the largest line item in the budget.
6) Volatility cuts both ways
The S&P 500 is down 1% or more 56 times this year, the most bearish volatility we’ve seen since 2008.
But volatility often goes both ways, and we saw that this week with the S&P 500 up 5.5% after a weaker-than-expected CPI. This was its biggest 1-day advance since April 2020 and the 15th biggest since 1950. A year later, the market has often been higher after those big up days (22 out of 24 times) with a average return of +31%. The 2 exceptions: September 30, 2008 and January 3, 2001.
7) The best strategy in 2022
2022 has not been a straight line, far from it. We have seen a series of selloffs and rallies in the S&P 500 with the Volatility Index ($VIX) going from below 20 to above 30 and back below 20 on several occasions.
As a result, a strategy that was only long on the S&P 500 when the $VIX closed above 30 and cashed out after closing below 20 would be up 25.6% since inception. of the year versus -15.9% for buy and hold and -33% for a strategy that did the opposite (long when $VIX closed below 20, cash after $VIX closed above 30 ).
What this illustrates: Buying weakness and selling strength has worked very well this year and if you did the opposite it was a source of additional pain.
Will it continue to operate?
Nobody knows. But at some point, the $VIX will fall below 20 and the market will continue to rally or the $VIX will rise above 30 and the market will continue to decline. This is why buy and hold is very hard to beat in the long run. No pattern lasts forever.
8) An epic change in leadership
In August 2020, Exxon ($XOM) was removed from the Dow Jones and replaced by Salesforce ($CRM).
Since then, Exxon has gained 219% against a 43% loss for Salesforce.
It is a microcosm of an epic shift in leadership, from growth to value and from technology to energy.
9) The most extreme ratio on the markets?
US equities have outperformed their international counterparts for nearly 15 years, and by a significant margin. As a result, a ratio of the S&P 500 to the rest of the world (MSIC World ex-US) ended October at its most extreme level in history.
10) Tesla on sale
Tesla stock is down 56.7% from its peak a year ago, its second-biggest decline since going public in June 2010.
Does that mean Tesla is cheap?
It would be hard to argue this case with an 8x price to sales ratio, but it’s certainly cheaper than it was in early 2021 when I wrote this post.
The same can be said for the median Nasdaq 100 company, which now has a price-to-sales ratio of 4.2x (from 8.5x a year ago), the lowest we’ve seen since 2016. “cheap” but definitely cheaper after a 35% drop last year.
11) Crypto’s Lehman Moment
In January, crypto exchange giant FTX saw its valuation soar to $32 billion as it raised $400 million in a new funding round. And as recently as September, FTX was in talks to raise another $1 billion at the same valuation.
Fast forward to this week and everything has changed. FTX filed for bankruptcy and its founder/CEO resigned.
The story is still unfolding, but at least part of the collapse appears to be the result of losses on the FTX token ($FTTUSD), which lost 90% of its value last week and was on FTX’s balance sheet. Suffering from a crisis of confidence, there was a rush to trade. Client withdrawals increased and FTX was unable to meet all demands, with a shortfall of up to $8 billion.
And that’s it for this week.
Have a great weekend everyone!
-Charlie
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