As bad as June's financial markets were for investors, July was the opposite. With worries over inflation, Fed policy, corporate earnings and a recessionary slide dialed up to the maximum, all it took was a bit of improvement from the worst expectations to move the markets higher. And boy did they rip. We have gasoline prices, Jerome Powell, and earnings from Amazon, Chevron and United Rentals to thank. This market is far from out of the woods, but the last two weeks showed that when you stretch a bungee cord far enough and the material holds, you can expect a good bounce. Air Captain Powell has not yet earned his second set of wings, but let's just say that the landing approach for the U.S. economy looks much better today than it did a month ago. But even Chairman Powell agreed that we all had better buckle into a five-point harness on our approach.
The majority of economic data points both in the U.S. and abroad continue to weaken. Some of the economic activity surveys and housing-related figures are slowing rapidly while others related to jobs and travel and leisure spending remain healthy. This slowdown is expected and needed to hammer the inflation spike back into the ground. Early signs point to some success, with energy and agricultural prices in a solid retreat while manufacturing input costs have also shown signs of slowing. The Treasury bond market suggests an economic weakening and reduced inflation expectations are taking hold. Meanwhile, the strength (or recovery) in public stock prices is suggesting that our worst fears over a collapse in sales and corporate margins are overblown. Look at the numbers below at Otis Elevator. Yes, the sales outlook has dimmed slightly, but operating margins will be fine and free cash flow will continue to be solid. So, assuming that earnings do not melt down, it will be difficult to punch stock prices to new lows. While some bears may still hold out for 3,000 on the S&P 500, opportunistic investors with dry powder or access to capital will be looking to take advantage of the lower public valuations. See Elliott going after PayPal last week. And see Pzena deciding to take themselves private. Look for credit investors to also put money to work where banks have closed their lending windows or where the public markets are shut to new borrowings. We technically might still have witnessed a recession, but it looks to be mild and also in our rear-view mirror. So those putting their capital to work today could be adding some meaningful basis points to their return streams.
While we are now past the bulk of large cap earnings, this week's slate is still a full one as the market transitions to the mid-cap and smaller-cap names. Still, plenty of great reads and data to look through in addition to this week's jobs data. August will be a slower month of activity as many squeeze in that last vacation and get the kids ready for school. Enjoy the eighth month and find a good place to stay cool.
And in July the markets soared to erase June...
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Nearly one-half of the 2022 U.S. markets decline was erased by July's gains...
And not just equities, but July was also a good month for high-yield credits...
Jumping stocks are interesting but jumping high yield bonds make me pay very close attention to the markets.
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Meanwhile the U.S. Treasury 10-year yield continues to break lower...
Evaporating along with long term inflation worries? Or acknowledging the slowing economy?
Deemer Chart List
The jump in credit and stocks is helping the U.S. financial condition index loosen...
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The second-quarter GDP report surprised to the downside, with the U.S. entering a technical recession...
There will be future revisions, but if it sticks, then this was a fairly mild slowdown.
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Most all of the focus and attention at last week's FOMC was on the outlook for inflation...
"My colleagues and I are strongly committed to bringing inflation back down, and we’re moving expeditiously to do so -- We've been saying we would move expeditiously to get to the range of neutral, and I think we’ve done that now. We’re at 2.25 to 2.5, and that’s right in the range of what we think is neutral -- There would be the risk of doing too much and, you know, imposing more of a downturn on the economy than was necessary. But the risk of doing too little and leaving the economy with this entrenched inflation, it only raises the cost. If you fail to deal with it in the near term, it only raises the cost of dealing with it later."
"Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2 percent. We anticipate that ongoing increases in the target range for the federal funds rate will be appropriate. The pace of those increases will continue to depend on the incoming data and evolving outlook for the economy. As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation."
"To the extent people start to see it as just part of their economic lives and they start to factor high inflation into their decisions, when that—on a sustained basis—when that starts to really happen—and we don’t think that’s happened yet. But when that starts to happen, it just gets that much harder, and the pain will be that much greater. So I really do think that it’s important that we—that we address this now and get it done."
- US Federal Reserve Chair Jerome Powell
The FOMC hiked the Fed Funds rate by 0.75% (as dictated) and the market reacted very positively...
It appears that Mr. Powell is in the zone with respect to his command over the financial markets on Fed Day.
Both the markets and Goldman Sachs are pricing in a 0.5% hike at the September meeting followed by a 0.25% hike at the November meeting...
Gasoline prices have fallen for forty-seven straight days...
U.S. manufacturers are reporting a sharp slowdown in prices. Even Elon Musk took to Twitter to report on it over the weekend...
The ISM Manufacturing Prices subindex in the United States decreased to 60 points in July from 78.50 points in June of 2022. It is the lowest reading since August of 2020, well below forecasts of 75.
Tom Lee notes the huge correction in the Fed Funds Rate outlook since the June FOMC meeting...
Over the past month, bond markets have drastically reduced their expectations for Fed tightening. This is evidenced by looking at Fed futures below:
- after June FOMC, markets saw Fed funds (mid-point) peaking at 3.81% in April 2023
- post July FOMC, markets now see Fed funds peaking at 3.28% in January 2023
- 53bp less on peak FF, or 2 hike reduction
- Fed funds peaking 3 months earlier
In other words, the bond market made a serious “dovish pivot” in pricing Fed funds into 2023. Is it any wonder that equity markets have found footing in July?
I had lunch with the founder of a local GP last week who expressed this same sentiment that the markets have overshot to the downside...
"Between the Fed and the media, I think you've [priced in] a pretty bad recession. So people kind of as I said if it's a hurricane they board it up, they put the plywood up and they've gotten ready for the hurricane. Now the part of the economy that probably isn't as ready and because there's no way to avoid it is the consumer. And I think you're seeing that the consumer has no way to really get out of the way of increased high gas prices and food inflation and things of that nature" - Moelis & Co CEO Ken Moelis
We would all worry if the credit/debit card companies were seeing a plunge in transaction volumes. But that is not happening...
"We're not economic forecasters, so I'm not going to predict the future or a potential likelihood of a recession. Instead, let's focus on the facts. From the numbers I just reviewed relative to 2019 levels, growth has been stable or improving in overall domestic payment volume, credit, debit, card-present, and card-not-present volume, and this indicates the most of 2022 with no indication of any slowdown, including in more recent weeks." - Visa CEO Al Kelly
"We had strong revenue and earnings growth again this quarter, as overall consumer spending remained robust and cross-border volumes grew 58% versus a year ago. Increasing inflationary pressures have yet to significantly impact overall consumer spending but we will continue to monitor this closely." - Mastercard CEO Michael Miebach
"For the month of July through 25 days -- It is up about 10% from last year’s July first three weeks. The transaction will grow by 7%. That means it is growing. People are spending on vacations. European transactions are through the roof right now. Theme parks, home improvement, a little more mitigated, but still holding on. Bigger than 19. People are missing the comparison with 19, which is critical. We feel good about the American consumer. They are spending" - Bank of America CEO Brian Moynihan
We would also worry significantly if cloud spending was showing signs of slowing but instead, it continues to grow rapidly...
"Moving on to Cloud, which surpassed a $6 billion quarterly revenue mark for the first time. Q2 revenue grew to $6.3 billion, with momentum across Google Cloud Platform and workspace -- Revenues were $6.3 billion for the second quarter, up 36%" - Alphabet CEO Sundar Pichai
"We saw another strong quarter of innovation and customer engagement in AWS, where net sales were $19.7 billion in Q2, up 33% year-over-year, and now represented an annualized sales run rate of nearly $79 billion. AWS continues to grow at a fast pace, and we believe we are still in the early stages of enterprise and public sector adoption of the cloud" - Amazon.com CFO Brian Olsavsky
“Azure and other cloud services revenue grew 40% and 46% in constant currency, about 1 point lower than expected, driven by a slight moderation in Azure consumption growth across customer segments” - Microsoft CFO Amy Hood
Microsoft's cloud revenue growth has moderated, but it is still growing at +46% q/q...
The four horsemen are back together again and rewarding the street with better than disastrous earnings...
@bespokeinvest: Give those mega caps a ribbon! This earnings season is on pace to be the first time since at least 2015 that AAPL AMZN GOOGL, and MSFT all reported in the same week and all 4 had positive reactions to their reports.
And not just big tech beating, but global luxury is also putting up better than expected numbers...
@WTCM3: Hermès continues to defy gravity with 10y sales/net income CAGRs accelerating by 100/200bps in 1H22 vs. YE21
Ditto over at LVMH as global luxury ignores the slowdown...
@ivan_brussels: LVMH H1 2022 earnings
- Revenue of €36.7bn, +28% YoY
- Profit from recurring operations rose to €10.2bn
- Strong sales in Europe, Japan and the U.S./ China impacted by health restrictions
- Robust growth at Louis Vuitton and Dior
Another big week of earnings with many familiar names to report...
And in another sign of a healthier market, consumer discretionary beats staples by the most in 21 years for July...
@LizAnnSonders: Worst month for Consumer Staples relative to Consumer Discretionary since January 2001
Speaking of the consumer, remember last week when Walmart preannounced, and their stock fell 10%?
It didn't take long for the stock chart to fix that gap lower. Not a sign of a broken market.
One of the more interesting looking tennis balls this weekend was the chart of industrial stocks...
@hmeisler: XLI. I was told you don't buy industrials going into a recession. Someone didn't get that memo.
Speaking of industrial stocks, look at this chart of United Rentals which was -30% YTD during June...
Big oil companies crushed earnings last week. The CEO of ExxonMobil explained it best...
"For a perspective on the current price environment, it’s important to consider the balance in supply and demand. Demand is recovering to pre-pandemic levels. However, for oil and gas, supply has attritted through depletion and reduced industry investment. You can see the significant reduction in industry oil investment in the graph. Industry investments were already low leading up to the pandemic. When the pandemic hit in 2020, economy-wide shutdowns dramatically reduced demand for crude. That deeply impacted industry’s earnings and cash flows. As cash flows came down, the industry sought to preserve cash, and further curtailed capital investments. As a depletion business, large annual investments in oil and gas production are needed to offset the decline in supply – roughly a 7% per year reduction. Even more investment is required to grow net production -- Clearly, to lower prices, the industry needs to increase investment and catch up to recovering demand. Unfortunately, this will take time." - ExxonMobil CEO Darren Woods
As I mentioned in the opening, here is the adjusted Otis Elevator outlook...
@bluff_capital: $OTIS Otis beats on eps, misses on rev. Lowers FY eps guidance.
And it continues... Earnings misses were baked into the stock prices...
@GinaMartinAdams: Stock price reactions to earnings misses in SPX are now the lightest in our records. Clearly sentiment got too bearish in front of this earnings season.
When massive selling turns to massive buying in high yield bonds, pay close attention...
@DeanChristians: The most interesting breadth thrust signal from last week that very few, if any, are discussing. What do the bond guys know?
Also seeing significant buying power in the equity markets...
@RenMacLLC: 20-day highs on the $SPX expanded to 56% Thursday, that's a rare and historically bullish message that should be heeded. #momentum
A strong July could also set the wind at the market's back...
@RyanDetrick: The S&P 500 had a huge month, up more than 9%. What now?
The good news is previous huge months opened the door to continued strength.
Since WWII, up a median 12.3% 6 months later and 17.6% a year later.
When boring is good...
Many investors enjoy chasing drone or scooter delivery retail. But sometimes the best returns in the market can be found by investing into a store selling wiper fluid, Slim Jims, and gasoline by the gallon while the CFO repurchases 5-10% of the companies’ shares outstanding on an annual basis.
When the public markets get irrational, the activists will come knocking...
Activist investor Elliott Management Corp. has a stake in PayPal Holdings Inc., according to people familiar with the matter.
The size of Elliott’s stake and its intentions couldn’t be learned. PayPal has roughly $8 billion of cash and short-term investments and not much more debt; activists are frequently drawn to companies they say could allocate capital more aggressively.
PayPal is a sizable target, with a market value of roughly $89 billion even after a significant downdraft in its shares. (At its peak about a year ago, the company was worth more than $350 billion.) The shares have lost around 60% so far this year, as e-commerce sales for which the company facilitates payments slowed amid the end of pandemic lockdowns.
PayPal shares in February suffered their worst one-day selloff on record after the company lowered its 2022 profit outlook and scrapped an ambitious growth strategy put in place last year of roughly doubling its active user base to 750 million accounts. Chief Executive Dan Schulman said the focus was on getting frequent PayPal users to utilize the company’s core services, such as online checkout and digital wallets, more often—and not on pursuing customers who are unlikely to transact regularly.
The activists can even be calling from inside the building...
Not a most enjoyable 15 years of being a public company. That 90% drop in value after going public would have been rough. Now management can focus on customers, employees, operations and not waste one-third of their time dealing with the public markets.
NEW YORK, July 26, 2022 (GLOBE NEWSWIRE) -- Pzena Investment Management, Inc. (NYSE: PZN) (“PZN”) today announced that it has entered into an agreement to become a private company through a transaction in which holders of PZN Class A common stock will receive $9.60 per share in cash. Under the terms of the definitive agreement, PZN will merge with and into a newly formed subsidiary of its operating company, Pzena Investment Management, LLC (“PIM”), in an all-cash transaction that implies an enterprise value for PZN of approximately $795 million. The $9.60 per share price represents a premium of 49% to PZN’s closing stock price on July 26, 2022, and a premium of approximately 46% over the 90-calendar day volume weighted average price...
Upon completion of the transaction, Pzena Investment Management will be a privately-held company owned by the existing partners of PIM. All of Pzena Investment Management’s leadership and investment professionals are anticipated to remain in place and will retain substantially all of their equity interest in the business.
“We are excited to begin this new chapter for our firm after 15 years as a public company,” said CEO Richard Pzena. “I would like to thank the Special Committee for its work in reaching this agreement. We believe the transaction is in the best interest of Pzena’s Class A stockholders, and will enhance our ability to achieve investment excellence on behalf of our clients.”
Pzena Investment Management
Speaking of activists and bottom fishing, who will be the first firm to make a run on a Macau casino?
Macau casino activity has completely collapsed. Someday the island and its casinos will reopen. We must be nearing the point of max frustration for some of the existing players. Either that or the fixed costs could be burning a hole in a few balance sheets.
The Daily Shot
The high yield market has closed down. Time for the opportunistic players to add to their returns...
Firms can issue debt, but credit market activity has slowed and many high yield companies have recently issued debt at unattractive rates. Bond yields have risen sharply since the start of the year. The higher yield environment has weighed on conditions in credit markets, but in particular the high yield market. Activity has slowed to a near stand-still with a monthly average of just $10 bn of issuance YTD (-77% vs. same period in 2021). The coupon rates on recent transactions have surged to 9%. The macro backdrop today carries many similarities to the late 2018 environment, including a hawkish pivot from the Fed and a 20% sell-off in US equities. During that period, high-yield issuance also slowed sharply.
Mario is fired up about the outlook for the private markets...
“I think… in ten years, institutional and high net worth investors will have roughly half their assets in private markets – not just private equity, but credit and real assets – because of the outperformance, and because they’ll realise that liquidity is vastly, vastly overrated as something that you have to have immediately,” says Mario Giannini, CEO of private markets giant Hamilton Lane...
“Private equity performs better because it’s a better governance structure than public markets,” Giannini says. “I think you have more control and better alignment of interests, and I think it can be done externally or internally. I think it’s a very different set of skills from public market investing – but do I think that it can only exist outside an institutional framework? I don’t.”
Giannini believes liquidity will also become easier to obtain around private assets – the secondary market will develop in a way where it’s more liquid due to innovations by groups like Nasdaq Private Markets, where investors might theoretically be able to see “something on their screen like a bid-ask price for an asset”. They’ll always be less liquid than the public markets, but they’re already more liquid than they were a decade ago.
Investor Strategy News
You can keep arguing about LeBron vs. Jordan, but...
A legend both on and off the court...
One of the most important lives in the history of sport and celebrity ended Sunday. Russell died at 88, leaving behind a sprawling legacy of greatness as a player, coach, civil rights activist and humanitarian. While it is fair to debate whether better individual basketball players have taken the court, Russell is an incomparable figure after factoring in team success at all levels (high school, college, Olympics and the NBA), leadership, adaptability, mental strength and societal impact off the floor. He was a star who did the dirty work, a defensive savant who led the Boston Celtics to 11 championships by excelling at whatever winning required. And he was a star who did the important work, a disrupter who demanded better from America and confronted racism without fear or fatigue.
He was a fully dimensional Black athlete more than a half century before it was okay to be one. In the 1960s, vandals broke into his house in the Boston suburbs, scrawled hatred on the walls and left feces in his bed. But there was no intimidating Russell. On the court, he went head to head with Wilt Chamberlain, a towering rival who, at 7-foot-1 and 275 pounds, was four inches taller and 60 pounds heavier than Russell. Still, Russell’s Celtics dominated the postseason matchups against Chamberlain’s teams. Though Chamberlain was an unstoppable force, Russell bested him with savvy, gamesmanship and his advanced understanding of the nuances of team play. He was just as astute in real life, too.
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