Note: view the video of this post here.
The charts and themes from the past week that tell an interesting story in markets and investing…
1) A Good Start
What a difference a year makes.
In the first 21 trading days of 2022, the S&P 500 was down 5%, the worst start for the index since 2016. This year, the S&P 500 has jumped out to a 7% gain, which is the best start we’ve seen since 2019.
Every major asset class finished higher in January, reversing part of the declines from 2022.
Many high growth stocks that suffered enormous losses in 2022 saw a sharp rebound in January…
Why are the markets rallying?
The current narrative: optimism over the fact that inflation is slowing fast and the Fed is expected to stop hiking rates in March.
Will the rally continue? The majority of respondents in my recent poll seem skeptical, believing this is just another bear market rally…
2) The Earnings Recession
Why are many still bearish?
For one thing, earnings, which continue to exhibit weakness.
S&P 500 Q4 GAAP earnings were down 20% year-over-year, the 3rd consecutive quarter of negative YoY growth and the largest decline since Q2 2020 (note: combination of actual/estimates with 37% of companies reported thus far).
S&P 500 Q4 2022 sales were up 6.4% year-over-year, the slowest YoY growth rate since Q4 2020. However, US CPI was 7.1% higher than last year, meaning sales growth was actually negative after adjusting for inflation.
But earnings tell you what’s already happened, not what’s going to happen. To know the path of the S&P 500 in the future, you need to not only predict what earnings will be in the future but what investors will pay for them.
It’s that second part that makes such predictions impossible, for the price investors will pay in the future is unknowable. At year end, the S&P 500 had a P/E ratio of 19.3 versus the historical average of 19.6 (since 1989), neither glaringly cheap nor expensive. Where it goes from here is anyone’s guess.
The multiple contraction we saw in 2022 (-15.6%) was due in large part to concerns about the slowdown in growth, particularly in the technology sector.
Microsoft’s numbers marked a continuation of that trend, with its 2% YoY increase in revenues marking the slowest growth rate for the company since Q2 2017.
Facebook’s revenues fell 4.5%, its 3rd consecutive YoY decline.
Not to be outdone, Intel saw its revenues fall a stunning 32% versus the prior year, the largest YoY decline in company history.
Intel was once an investor favorite during the dot-com bubble, but it has not aged well. Including dividends, the stock is 39% below its August 2000 peak. The S&P 500 has quadrupled since then (total return with dividends).
3) The Tale of Tesla
The unrivaled investor favorite during the recent boom was Tesla, the top performing stock in the S&P 500 during 2020 with a return of 743%. After gaining another 50% in 2021, it fell back to earth in 2022 with a 65% decline.
After hitting a peak of 30, its price to sales ratio moved all the way down to 5 by early this year, and currently sits at 8 (vs. 2x for the S&P 500).
Where its valuation moves next will be driven by expected growth rates and sentiment. While Tesla’s revenues continue to grow at a faster pace than the market, the slowdown in recent quarters is notable. The 37% increase in YoY revenues is the lowest growth rate for Tesla since Q2 2020.
4) Shrinking Money Supply
The record increase in the US Money Supply was a major tailwind during the mania of 2020/2021 and a significant headwind during the bear market of 2022.
The Money Supply has now fallen 1.3% over the last 12 months, the first year-over-year decline on record.
2022 was the first calendar year in which the Money Supply contracted in the last 60+ years.
5) More Signs of Lower Inflation
As the money supply has moved lower, so has the rate of inflation. A few more indicators on that front…
- The PCE Price Index was up 5% year-over-year, its lowest increase since September 2021. It peaked back in June 2022 at 7%.
- US Rents fell 0.4% in January, the 5th straight monthly decline. The year-over-year % increase has now moved down for 14 consecutive months after peaking at 18.1% in November 2021. At 3.3%, this is the smallest YoY increase since April 2021.
- The rate of US home price appreciation continues to slow, up 7.7% YoY nationally according to the Case Shiller Index. This is lowest YoY increase since September 2020 but is only as of November. Real-time data shows YoY appreciation has moved down to 1% with prices 11% below their peak.
- The Case Shiller 20-City Home Price Index moved down for a 5th straight month, the longest down streak since 2012. San Francisco home prices moved negative YoY, the first major city in the index to do so since 2019.
6) Eggflation
One notable exception to the trend of slowing inflation has been the skyrocketing cost of eggs. A dozen large, grade A eggs went from $1.79 to $4.25 over the last year, the largest 12-month % increase on record (+138%).
What’s driving this?
A major shock to supply. More than 57 million birds have died from avian influenza (bird flu) in the past year, the worst outbreak in US history.
The spike in prices is leading some to people to take matters into their own hands…
7) Inflation: What is it Good For?
While inflation had been eating away at the purchasing power of US consumers, there’s one group that has actually benefitted from higher inflation: debtors.
Why?
Because when prices rise at a rapid pace, borrowers are paying old debt back with money that’s worth considerably less.
When it comes to debtors, there’s no one bigger than the US government. The National Debt increased to over $31 trillion in 2022, more than $8 trillion higher than where it ended 2019. But if you look closely at the table below, the Debt to GDP ratio has actually moved lower in the past 2 years, from a year-end peak of 128% in 2020 down to 120% today.
Why? High inflation caused nominal output to spike, rising faster than new debt issuance. While the National Debt rose $3.7 trillion over the last 2 years, nominal GDP rose $4.4 trillion.
For those concerned about the US defaulting on its debt, a quote from a former Fed chairman may set your mind at ease…
“The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” – Alan Greenspan
8) The End of Easy Money
As expected, the Fed hiked rates for the 8th time in the last year, a 25 bps increase to a new range of 4.50%-4.75%. This is now the highest Fed Funds Rate since October 2007.
The Fed Funds Rate has now moved back above Core PCE (the Fed’s preferred measure of inflation) for the first time since 2019. Since 2008, the only other period with a Fed Funds Rate above Core PCE was October 2018 to September 2019. That ended with Fed rate cuts in 2019, another round of QE, and a move back to easy money.
9) Will There Be an Official Recession This Year?
That’s a question many have been asking. But after the 4th quarter GDP report, it seems they’ll have to continue to wait for an answer. It showed another new high for economic output, with Q3-Q4 bouncing back after consecutive declines in Q1-Q2.
The growth rate, however, continued to slow as compared to the prior year. The 1% year-over-year increase is the slowest since Q2 2020.
Meanwhile, the indicators of future economic weakness continue to build, with the yield curve becoming more and more inverted.
But the recession will not commence until the US consumer really pulls back, and one major driver of that will be interest rates. Credit Credit debt has been rising fast of late, and the cost of that debt is has now spiked to over 19%. This is the highest rate on record with data going back to 1995. How long will it take before this starts to impact spending? That will be one of the key questions for the economy this year.
10) Tapped Out
Crude Oil in the US Strategic Petroleum Reserve was unchanged over the past 2 weeks, bringing to an end a streak of 71 consecutive weekly declines. Oil Reserves are currently at their lowest levels since 1983 after a record 37% decline last year.
Some have said the decline in gas prices in the back half of last year was due to the decline the level of reserves. But in reality, this was all about optics. The market for Crude Oil is a global market and selling down the Strategic Petroleum Reserves added less than 1% to the daily supply of Oil, not nearly enough to make any meaningful difference in prices.
Over the past month, we’ve seen gas prices start to move up again, rising $0.33/gallon. This is slightly higher than a year ago but still well off the peak of over $5.00/gallon from last June.
11) Why You Diversify
From 2009 through 2021, diversification seemed almost irrelevant. If you simply owned the big 4 (Apple, Amazon, Google, and Microsoft) and nothing else, you would have outperformed everything by a wide margin.
The dominance of US large cap, growth equities during this period was rivaled in history only by the Tech bubble of the 1990s which peaked in 2000. As a percentage of the S&P 500, the concentration of the top 5 holdings actually surpassed that historic bubble, rising to a record 23.6% by the end of 2021.
But there’s a cycle to everything, and in 2022 investors learned that once more. 2022 was the first year since 2008 in which Apple, Amazon, Google, and Microsoft all finished lower AND all underperformed the S&P 500…
At the same time, Growth stocks underperformed Value stocks in 2022 by 21.6%, the 2nd widest spread on record with data going back to 1979. Only 2000 (dot-com bubble bursting) showed a greater differential (-29.6%), which was followed by 6 more years of Value beating Growth (2001-2006).
The S&P 500 underperformed the equally weighted S&P 500 by 6.7% in 2022, the largest underperformance since 2010.
And international stocks (MSCI EAFE) outperformed US Equities (S&P 500) by 4.1%, their biggest outperformance since 2009.
No one knows if these trends will continue, and if this marks a similar turning point to 2000. Which is precisely why you diversify, to protect yourself from your inability to predict the future in preparing your portfolio for multiple possible outcomes.
And that’s it for this week. Have a great weekend everyone!
-Charlie
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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. Read our full disclosures here.
