19 Apr Capital 19 Catch-Up
Weekly Index Movement
Aussie All Ords +0.6%
US Stocks fell again last week as rising interest rates and fears of recession once again sapped confidence.
Stocks can’t seem to find any direction these days, and that’s being somewhat generous. If anything, the trend has been lower.
The 200-day moving average is typically considered a major trendline for the S&P 500 with breaks above considered bullish, while moves below suggest a bearish outlook.
If that’s the case, what are we to make of the fact that the S&P 500 has crossed above its 200-DMA more than five times this year and crossed below it six times? As we’ve all said to our kids all too often, “Make up your mind already!”.
In all seriousness, you can’t really fault investors for the indecision. There’s no shortage of uncertainty out there concerning the economy and the geo-political situation, but the impact of the Fed looming on the markets right now ranks just as high. Everyone knows that the FOMC is going to hike rates considerably in the next several months, the only question is by how much.
We are expecting +50Bps in both May and June as the Fed continues to battle inflation.
We had two reads on inflation last week. CPI came in on expectation at +8.5% and PPI inflation showed producer prices at their highest levels since the 1970s at +11.2%.
These readings are expected to be the cycle high and future inflation to reduce. If this is the case, it would be positive for stock prices.
Inflation is measured as a comparison to last year, and it is true that the comparisons will get harder for inflation to exceed over the next few months.
For example, March 2021 inflation was +2.7%, so March 2022 had that +2.7% hurdle to print a big number. But April 2021 was +4.2%, May 2021 was +4.9% and June 2021 was +5.3%.
If the cost of goods remains the same over the next 3 months, it will appear that inflation is reducing, but it is only down to the comparisons having a higher starting number.
A wealthy friend of mine once told me “It isn’t how much you make, but how long you make it”. That got me thinking about inflation as the same thing is true here.
If inflation is transitory then you want to buy stocks here as they should recover as inflation reduces.
The European Central Bank certainly thinks so.
But we think they are wishing it down rather than forecasting from any position of knowledge. With this kind of idiotic planning by the ECB we fear what is in store for the region and recommend you stay well away from European equities.
Rather than neatly forecast inflation will drop to the desired band by the end of the year and then just stay there for the next few years (I still can’t quite get over how ridiculous that ECB forecast is), I thought I would take a look at what the market is telling us.
The bond market has products called Treasury Inflation Protected Securities. By examining the price of these TIPS we can see what the market is predicting for long term inflation.
5 year TIPS think inflation will average out at +3.59%
10 tear TIPS have it at 2.95%
Whilst this market is telling us 8% inflation will wane, both readings are well above the Fed’s 2.0 percent target. It tells us the market does not think the Fed can control inflation because it is being caused by commodity constraints and de-globalisation, which are outside of the Fed’s sphere of influence.
Takeaway – expect inflation to moderate but remain elevated for several years.
The stock market does some wild swings in the short term, but growth in earnings can nearly 100% explain the growth in stock prices in the long term. Earnings growth is the single most important factor to watch.
In 2018-2019 the S&P500 earned an average of $40/share per quarter.
In Q4 2021, the S&P earned $55/share
That is an increase in earnings of 37.5%
The S&P is 36.8% higher today than the closing price of 2019. Pretty much exactly in line with earnings growth.
It also justifies the level of the index and shows that stock prices are certainly not overvalued here.
This is why the direction of earnings is so crucial. If the index can hold $55/share/quarter this year, then US large caps will be ok. You might not make much, but the downside will be limited.
The problem is the market has earnings at $51.60 for Q1, so either we need a significant 6%+ beat this quarter or the following quarters need to beat by even more to maintain the $55 average.
Earnings season has started which gives us a very early look at where earnings might come in this quarter.
Citibank (C) reported earnings of $2.02 which smashed expectations by 41% but the problem was earnings were down 44% on same period last year.
JP Morgan (JPM) reported $2.63, slightly missing estimates and down 42% on same period last year.
Wells Fargo (WFC) beat, but were down 16% on same period last year.
You can see the trend, and this is our concern for stock prices in general. We will get the tech giants reporting next week so hopefully they can give us a lift.
Jamie Dimon Is Uncertain About What to Expect This Year
Jamie Dimon is the CEO of JPMorgan Chase and he likes to dish out his sentiment on the economy. As usual, last week he had a lot to say.
He doesn’t like forecasts and he won’t make forecasts that he isn’t certain about
“I can’t forecast the future any more than anyone else,” Dimon said, adding, “the Fed forecasted and everyone forecasts and everyone’s wrong all the time.”
However, he believes that economic growth will continue at least through the second and third quarters of this year. His reasoning: Consumers and businesses are flush with cash and still paying off debts on time. The recent quarter saw a 15% increase in consumer and small-business deposits.
But after the third quarter? Dimon said:
“After that, it’s hard to predict. You’ve got two other very large countervailing factors which you guys are all completely aware of,”
He was referring to inflation and the Fed increasing interest rates. He called these “storm clouds” that might or might not disappear. As a result, JPMorgan set aside $902 million in new funds of loan loss reserves to prepare for any economic turmoil. Dimon said the risk remains small but is growing after Russia’s invasion and surging inflation.
“Those are very powerful forces and these things are going to collide at one point, probably sometime next year,” Dimon said during a media conference call. “And no one actually knows what’s going to turn out so I’m not predicting a recession. But you know, is it possible? Absolutely.”
However, Jamie Dimon was sure of one thing — the market will stay volatile:
“I cannot foresee any scenario at all where you’re not going to have a lot of volatility in markets,” he said. “That could be good or bad for trading, but there’s almost no chance it won’t happen.”
We agree with his comments about volatility. The best approach here is to play defensively. We continue to favour energy and healthcare and will avoid tech until we see more evidence of significant reductions in inflation.
The Coming Week
It is all eyes on earnings reports this week with several blue chip companies reporting – IBM (IBM), Procter & Gamble (PG), Travelers (TRV), Johnson & Johnson (JNJ), American Express (AXP), Netflix (NFLX) and Telsa (TSLA).
There are no significant economic reports.
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.