Weekly Research Briefing: "Houston, we have a problem"

May 03, 2022
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I didn't plan on writing a WRB this weekend due to some travel and family obligations, but given the market's move last week, I felt it was important to convey some thoughts.

The tide continues to go out for the financial markets. As we have discussed, the world's Central Banks (led by the Fed) are emptying the punch bowls of easy money, which is pushing interest rates higher and making access to capital slightly more difficult. As the ability to make money in the public equity and debt markets becomes more difficult, investors are pushing their expected returns higher, which is impacting the multiples and valuations that they are willing to pay. Unfortunately, this is occurring simultaneously to the war in Ukraine and new COVID lockdowns in China, which are causing investors to question global growth potential and companies’ earnings growth abilities. Current earnings results are mostly strong and future guidance remains good, but new question marks are causing analysts and investors to lower their price targets. While institutional investors have prepared somewhat for a more defensive equity environment, the retail investor base still appears to be very committed to equity investments, especially those in the higher growth areas of the market. Will the retail appetite remain if growth stocks underperform for the foreseeable future? Don't forget that summer seasonality is now among us.

According to Bespoke, 2022 is the worst start to a year on record for the Nasdaq, with a year-to-date performance through April 30 of -19.8%. Even more broadly than just the Nasdaq index, there is too much volatility in stocks, bonds, commodities and currencies to make an investor feel good about taking on risk right now. This quarter's earnings releases should be a positive catalyst for stocks, but the market really doesn't seem to care. We also thought that the end of April stock rebalances should have helped the stock market, but they didn’t, with April finishing on its lows. Maybe the post-earnings return of stock buybacks can help ease some of this year's stock market decline, but they will be most beneficial to those companies generating cash flow above and beyond what they need and where stocks are believed to be undervalued. This could help to explain why the consumer staples sector was the only area in positive territory for the month of April. Meanwhile the XBI (Biotech ETF) fell 18% in April, which was its second-worst month ever (save for January 2016, when it fell 28%).

It is a big week for the markets. The FOMC will decide on its May Fed Funds interest rate increase. Ninety-nine percent of eyes are looking at a 50-basis point increase. On Friday all eyes will be on the jobs data releases. Nonfarm payrolls are targeted to grow by 400,000 jobs and the unemployment rate should fall to 3.5%. With two-thirds of S&P 500 companies having already reported earnings, there is still another 10-15% hitting this week while the Small/Mid-Caps begin their earnings results ramp. So, lots of data to look at, but will the market even care given its foul mood right now? As Bill Gurley reiterated over the weekend, this is a time to focus on actual cash-making metrics. Sky high price to sales and other bubble market metrics will not work anymore. Investors need to buckle up and become even more disciplined about which companies will survive a potential slowdown. If you are an investor focused in high growth, unprofitable companies, then you will want to increase your stack of summer reading books and buy some new fishing lures. Hopefully this doesn't end up being applicable advice for all public equity investors this summer. Stay safe out there.


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Just an ugly start to the year for growth stock investors...

@bespokeinvest:
2022 - the worst start to a year on record for the Nasdaq.
YTD thru April:
2022: -21.2%
1973: -19.4%
2001: -14.3%
2002: -13.4%
2005: -11.7%
1984: -11.2%

US job vacancies rate

@cperruna


Actually, a pretty foul end to April for all U.S. stock investors...

@bespokeinvest: Friday was the second worst final trading day of a month in SPY's history dating back to 1993.

US job vacancies rate

@bespokeinvest


In the past, we have had catalysts to recover from oversold growth stock markets, but unfortunately, the Fed will be sitting out this next assist...

@murphycharts: $NDX Nasdaq 100 Index % of stocks > 200 DMA, weekly closing price. Crosses below 20% for the first time since March '20.

Market pricing for the number of 25 bps Fed rate hikes

@murphycharts


Just too much volatility in growth stocks right now but at least we now have a name for this specific volatility...

Even though overall realized volatility has been far from COVID or GFC highs, the frequency of moderate-sized market moves has been high, especially for Growth stocks. The Russell 1000 Growth index has moved +/- 1% on 70% of trading days since late November - just about the highest frequency of such moves it has had on record. The steady stream of market movement without huge individual one-day moves is what's statistically called platykurtosis (a thin-tailed distribution) - a rare moment for a typically-fat-tailed equity market.
(Goldman Sachs)

Market pricing for the number of 25 bps Fed rate hikes

Unprofitable growth stocks are now in year two of their pain...

@LizAnnSonders: Spectacular rise and fall of non-profitable tech: since S&P 500’s pre-pandemic peak in February 2020, speculation-fueled cohort (orange) now underperforming broader market (blue), having collapsed in relative terms

Market pricing for the number of 25 bps Fed rate hikes

Value stocks have done very well recently, but this road could be a very long one...

@bespokeinvest: Value’s massive outperformance versus growth recently looks like this on a long-term chart:

Wide distribution of outcomes after historical yield curve inversions

@bespokeinvest


Forward P/E valuations have pulled in, but what is the catalyst to stop them from falling now?

@FactSet: The forward 12-month P/E ratio for $SPX of 18.1 is below the 5-year average (18.6) but above the 10-year average (16.8).

Wide distribution of outcomes after historical yield curve inversions

And with bond yields risen, dividend-paying stocks now have some competition for investors...

@strategasasset: In the Q.E. era, when the percent of S&P 500 stocks has reached the 20% level, where it stands today, rates have historically reversed. But, of course, at each of those previous points, inflation was significantly lower, and the Fed was not at the beginning of a rate hiking cycle

Wide distribution of outcomes after historical yield curve inversions

With April returns now in the books, the one-year return rolls are going negative...

@hsilverb: $SPX and major indices returns as of April 2022

Wide distribution of outcomes after historical yield curve inversions

The S&P 500 chart does not look investor friendly...

Wide distribution of outcomes after historical yield curve inversions

StockCharts.com


Earnings are mostly good and estimates are holding tight, but multiples are being cut...

Analysts and investors are aware of the potential for slower economic growth, rising wages, and greater uncertainty. Target prices are being cut at many high growth companies as analysts reel in their multiple targets.

Cumulative personal savings in the pandemic

@EarningsScout


J.P. Morgan notes the better U.S. earnings period and rising forward estimates. But the market just doesn't care...

US: 79% of S&P500 companies that have reported beat EPS estimates. EPS growth for these companies is broadly flat at +1% y/y, surprising positively by 6%. Earnings delivery at a sector level is mixed: Energy and Industrials continue to be helped by easy comps, with Industrials and Discretionary reporting healthy growth, too. On the other side, Financials and Communication Services are printing negative growth. Top-line growth in the US is coming in at +11% y/y, surprising positively by 2%.
(J.P. Morgan)

Cumulative personal savings in the pandemic

JPMorgan


Ditto for the European results reported so far...

Europe: Of the Stoxx600 companies that have reported so far, 69% beat EPS estimates. Q1 EPS growth is coming in at +11% y/y, surprising positively by 9%. In Europe, commodity sectors and Staples are printing strong growth numbers. Revenue growth is at +9% y/y, surprising positively by 5%. (J.P. Morgan)

Wide distribution of outcomes after historical yield curve inversions

JPMorgan


Another sizable week of earnings reports to chew on...

Wide distribution of outcomes after historical yield curve inversions

@eWhispers


Investors may not have liked Amazon's earnings report, but you have to love their commentary regarding the U.S. supply chain...

@conorsen: This is probably the most macroeconomically-significant statement about supply chain improvement that we've gotten since bottlenecks emerged last spring: $AMZN

Commodities

Even Sherwin-Williams had positive things to say about raw material availability...

Best Year for Commodities

@bluff_capital


Microsoft was the best of the FAMANG stocks when it came to its earnings report, but again, investors did little to reward Mr. Softie...

As CEO Satya Nadella noted on the Q3 conference call, these stellar results - another quarter of 30%+ top-line growth on a nearly $100 billion Cloud revenue base – are reflective of Microsoft’s massive long-term opportunity (TAM): “Going forward, digital technology will be the key input that powers the world’s economic output. Across the tech stack, we’re expanding our opportunity and taking share… Leading organizations of every size and in every industry trust the Microsoft cloud.”

Today, the Cloud businesses account for just under 50% of Microsoft’s total revenues. Said differently, even if the remaining businesses at the company are unable to grow (they can and they will), the contribution from the 30%+ revenue growth in the Cloud businesses alone is enough to drive double digit topline growth. This has quickly become the driving force of Microsoft’s business – and it has led to revenue growth rates for the company that seemed unimaginable five years ago. (In addition, as the cloud businesses have scaled, corporate EBIT margins expanded by >1,000 basis points.)

Best Year for Commodities

The Science of Hitting


Incredible revenue growth breadth...

After the Flood

@CJOppel


Can company stock buybacks help save the market in May?

We expect S&P 500 buybacks will grow by 12% year/year in 2022 and remain the largest source of demand for US equities. Solid earnings growth (+5%) and large cash balances among S&P 500 firms will support continued buyback growth. Managements have indicated a desire to return excess cash to shareholders in the form of repurchases. Buyback authorizations, a signal for subsequent executions, totaled $1.2 trillion in 2021 and have surpassed $400 billion YTD, 22% above the record pace at this time last year.
(Goldman Sachs)

S&P 500

If you were looking for an excuse to turn off your trading platform for the next six months...

@RyanDetrick: The next six months are historically the worst on average. Widely known as the "Sell in May" period.

S&P 500

It looks like investor outflows from equity funds are accelerating with the falling returns...

S&P 500

Goldman Sachs


But retail investors seem rather committed...

@TommyThornton: Next this MS chart showing the 3 month rolling period showing institutions have been selling while retail has not...yet

S&P 500

Hmmm…

The big declines in fixed income returns are pushing investors to consider increasing their durations...

S&P 500

And here is that fixed income underperformance...

…this backdrop has contributed to an almost full disappearance of negative yielding debt globally and kept 2022 on track to become by far the worst year for J.P. Morgan GBI World index, at least since 1990 (Figure 17). This is not only because of the magnitude of change in yields, but also because the record high duration and record low carry on Fixed Income benchmark… (J.P. Morgan)

US IPO Proceeds and Activity

If the public market is not interested, the private market could be...

US IPO Proceeds and Activity

While public equity investors give up on global stocks, the private equity industry is sharpening its pencils...

The steep drop in share prices of recently-listed European companies is making them prime targets for buyout firms on the prowl for cheap assets.

Polish parcel-locker operator InPost SA, U.K. online shopping emporium THG Plc and German enterprise software developer SUSE SA have been reported to attract private equity suitors in recent weeks. All three listed on European exchanges over the past 18 months and are now trading below their initial public offering prices.

A wave of businesses have gone public in Europe over the past two years, particularly tech and online services companies during the pandemic. But appetite for high-growth assets has cratered in recent months as economic reopenings, the prospect of rising interest rates and surging inflation weigh on sentiment.

“The ultimate arbiter of investment return is the valuation paid to access a company’s profit and cash flow streams,” said Russ Mould, investment director at AJ Bell Plc, adding that the poor performances created an “opportunity for the cash-rich, patient private equity industry to take a firm private and work on a turnaround without the pressure of regular earnings releases.”

Almost two-thirds of the IPOs that raised at least $500 million on European exchanges since the start of 2020 are now trading in the red, data compiled by Bloomberg show.

Bloomberg


Even Mattel is thinking about going private. A successful turnaround plus an unrewarded stock equals a CEO and management team looking for a new investor base...

Mattel Inc. has held talks with private-equity firms about a potential sale, people familiar with the matter said, just a few months after the famed toy company declared its corporate turnaround complete.

Mattel has held informal talks with firms including Apollo Global Management Inc. and L Catterton, the people said. The talks are at an early stage and may not result in a deal.

If there is one, it would be sizable. Mattel had a market capitalization of about $8 billion as of the close of the market Tuesday. It would add to a recent string of big leveraged buyouts, as private-equity firms look to spend a mountain of cash they have accumulated.

Chief Executive Ynon Kreiz said in February that Mattel had completed its turnaround and was “now in growth mode.” Mattel reported a sales jump of 19% in 2021 and said profits rose. Yet its shares have barely budged over the past year and have done little in the past two decades.

WSJ


Growth stock investors might take the summer off, but private equity firms will be busy...

@bespokeinvest: At the end of April, the average Russell 1,000 stock was in a drawdown of 27.4%. Communication Services and Technology stocks are at -35%+.

Flipped Home Transacations

@bespokeinvest


Falling stock prices have led to a surge in public company takeovers in 2022...

For the first four months of 2022, 31 U.S. listed companies have offers to go private amounting to $185 billion. This represents about 0.42% of the U.S. listed market capitalization. In addition, 25 U.S. listed companies have offers to be bought by other public companies in the amount of $169 billion. This represents about 0.38% of the U.S. market cap. (Russell 3000 has 2,760 companies in its index representing $44 trillion in market cap and about 98% of the total U.S. stock market.)

These numbers are a significant increase from the first four months of 2021 which is surprising to me. Not only were their fewer offers made to U.S. public companies a year ago, but there were also many deals that were rejected or never made it to the finish line (like Kansas City Southern, Hartford Financial and Carrefour). I am guessing that more of the 2022 transactions will close as many of the current deals in the works are more friendly and with fewer hurdles ahead of closure. If the first 4 months are representative of the rest of 2022, we could be looking at a good shrink in public company capitalization leaving the market. Maybe on the order of 2%.

Flipped Home Transacations

S&P Capital IQ Pro data through 4/26/2022


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The author has current equity ownership in: Microsoft Corp.

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