Notes:
-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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This week’s post is sponsored by YCharts. Mention Charlie Bilello to receive a free trial and 20% off your subscription when you initially sign up for the service.
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The charts and themes from the past week that tell an interesting story in markets and investing…
1) Stairway to Recession
As expected, the Fed hiked rates another 0.75% last week to a new range of 3.75-4.00%. This was the 4th straight 0.75% hike and 6th rate hike of the year. The current Fed Funds Rate is now at its highest level since January 2008.
What happens next?
More hikes, but with increasing odds of a smaller increase. Powell alluded to this at the FOMC press conference in saying a slower pace “may come as soon as the next meeting or the one after that.”
Market participants are now pricing in that just that, expecting a 50 bps hike in December (to 4.25-4.50%) and a 25 bps hike in February of next year (to 4.50-4.75%). After that, one more 25 bps hike is expected in March 2023, bringing the Fed Funds Rate up to 4.75-5.00%.
From there, markets are currently anticipating a pause followed by a new rate cutting cycle starting in November 2023.
What would cause the Fed to stop hiking and move in the opposite direction?
a) Inflation moving considerably lower.
b) The economy showing additional signs of weakness.
2) Moving in the Right Direction
On the first point, the inflation rate in the US moved lower in October for the 4th consecutive month. At 7.7%, this is the lowest year-over-year increase we’ve seen since January.
More importantly as it pertains to Fed policy was the slower rate of growth at the core level (excluding food/energy), which grew 6.3% versus an estimated 6.6% increase.
A big part of the increase in core inflation continues to be the all-important “Shelter” component, which moved up to 6.9% in October. This is the largest increase we’ve seen in that category since 1982.
But CPI Shelter continues to be a lagging indicator, as the real-time housing data has been moving in the opposite direction…
a) Rents are up 5.8% year-over-year, the smallest rate of increase since May 2021.
b) Home prices are up 3.2% year-over-year, their slowest growth rate since the start of the pandemic.
At some point, Shelter CPI will start reflecting this new data, but we don’t appear to be there just yet. There remains a considerable gap between reported and actual housing inflation that will likely be closed in part by continued increases in Shelter CPI.
3) Why the Fed Will Continue to Hike
While there’s increasing pressure on the Fed to reverse course, Powell doesn’t seem to be on board with that line of thinking, saying forcefully that the “historical record cautions strongly against prematurely loosening policy” and that they will “stay the course until the job is done.”
How will we know when the job is done?
One important guidepost will be when wages outpace inflation again, something we haven’t seen for 19 months in row (a record). This is a decline in prosperity for the American worker (erosion of purchasing power) and is the primary reason why the Fed will continue to hike rates.
4) The Monetary Policy Lag
The full impact of this year’s rate hikes has yet to be seen, as there’s a notorious lag between monetary policy actions and its impact on the real economy.
The labor market still appears to be tight (4.7 million more job openings than unemployed persons) and jobs grew in October for the 22nd consecutive month.
While the Unemployment Rate did tick up to 3.7%, it remains very low on a historical basis.
But as the economy slows as we head into 2023, we should expect to see this number rise, and within the Tech sector we’re already seeing a dramatic shift in the landscape.
A summary of some of the layoffs this year…
- Twitter: cutting 50% of its workforce (estimated 3,700 jobs).
- Facebook ($META): cutting 13% of its staff (11,000 jobs), its largest round of layoffs ever.
- Snap ($SNAP): cutting 20% of its workforce (1,200 jobs).
- Shopify ($SHOP): cutting 10% of its workforce (1,000 jobs).
- Netflix ($NFLX): cut 450 jobs in two rounds of layoffs.
- Microsoft ($MSFT): cutting <1% of workforce (1,000 jobs).
- Salesforce ($CRM): cutting 1,000 jobs.
- Robinhood ($HOOD): cutting 31% of its workforce.
- Tesla ($TSLA): cutting 10% of its salaried workforce.
- Lyft ($LYFT): cutting 13% of its workforce (700 jobs).
- Redfin ($RDFN): cutting 13% of its workforce.
- Coinbase ($COIN): cutting 18% of its workforce (1,100 jobs).
- Stripe: cutting 14% of its workforce (1,000 jobs).
An addition to these cuts, Amazon ($AMZN) has announced a hiring freeze, Apple ($AAPL) has paused almost all hiring, and Google ($GOOGL) is reducing new hiring by 50%.
5) Rising Cost of Money
With inflation outpacing wage growth, the US consumer has resorted to saving less (lowest savings rate since 2008) and borrowing more (credit balances rising at fastest pace since 2011) in order to maintain their spending.
And the interest rate on that credit card debt has moved up to 16.27%, the highest rate on record (note: data goes back to 1994).
The rise in the Fed 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 hit an all-time low of 2.37%.
At the Federal Government level, rising rates are leading to a rapidly rising interest expense on Public Debt. At $747 billion over the last year, this is a record high and at the current pace will soon be the largest line item in the budget.
6) Volatility Cuts Both Ways
The S&P 500 has declined 1% or more 56 times this year, the most downside volatility we’ve seen since 2008.
But volatility often cuts both ways, and we saw that this week with the S&P 500 rallying 5.5% after the lower-than-expected CPI number. This was its largest 1-day advance since April 2020 and 15th largest since 1950. One year later the market has often been higher following these big up days (22 out of 24 times) with an average return of +31%. The 2 exceptions: September 30, 2008 and January 3, 2001.
7) The Best Strategy in 2022
2022 has not been a straight line down – far from it. We’ve seen a series of sell-offs and rallies in the S&P 500 with the Volatility Index ($VIX) moving from below 20 to above 30 and back below 20 again on multiple occasions.
As a result, a strategy that only went long the S&P 500 when the $VIX closed above 30 and to cash after it closed below 20 would be up 25.6% YTD 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’ve been doing the opposite it’s been a source of additional pain.
Will it continue to work?
No one knows. But at some point, the $VIX will fall below 20 and the market will continue to rally or $VIX will rise above 30 and the market will continue to fall. Which is why buy and hold is very hard to beat in the long run. No pattern lasts forever.
8) An Epic Shift in Leadership
In August 2020, Exxon ($XOM) was removed from the Dow and replaced with Salesforce ($CRM).
Since then, Exxon has gained 219% versus a 43% loss for Salesforce.
This is a microcosm of an epic shift in leadership, from Growth to Value and from Technology to Energy.
9) The Most Extreme Ratio in Markets?
US equities have been outperforming 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 largest drawdown since its IPO in June 2010.
Does that mean Tesla is cheap?
It would be hard to make that case with a price to sales ratio of 8x, but it’s certainly cheaper than it was in early 2021 when I wrote this post.
The same can be said for the median company in the Nasdaq 100, which now has a Price to Sales ratio of 4.2x (down from 8.5x a year ago), the lowest we’ve seen since 2016. Not “cheap” but most definitely cheaper after the 35% decline in the past year.
11) Crypto’s Lehman Moment
Back in January, Crypto exchange giant FTX saw its valuation rise to an astounding $32 billion as it raised $400 million in a new round of funding. And as recently as September, FTX was in talks to raise another $1 billion at the same valuation.
Fast forward to this week and everything has changed. FTX filed for bankruptcy and its founder/CEO has stepped down.
The story is still unfolding, but at least part of the collapse appears to be the result of losses in the FTX Token ($FTTUSD), which has lost 90% of its value in the last week and was held on FTX’s balance sheet. Suffering from a crisis of confidence, there was a run on the exchange. Customer withdrawals spiked and FTX was unable to meet all requests, with a reported shortfall of up to $8 billion.
And that’s it for this week.
Have a great weekend everyone!
-Charlie
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