Private Wealth

Weekly Research Briefing: Grab The Aviators

July 18, 2022

No rose-colored glasses this month for either the triple digit heat or the double-digit Fed Funds rate hike. I just can't see the FOMC raising by 100 basis points and then running off for vacation for two months. There is clear evidence that the excess heat in the economy is cooling rapidly and equally good data showing that price pressures are easing. Job growth continues to be strong, but many large employers, especially in the technology sector, have announced pauses in hiring. Consumers are still flush with cash and retail spending is strong, unless you are looking at bigger ticket purchases like a car or house. This 250-basis point increase in interest rate expectations has taken the wind out of the economy's sails just as intended. Now we watch the slowdown and keep a close eye on jobs data and credit quality data to see if there is any real economic damage. A cooling of the economy could mean that current equity and debt prices should be bought. A worse slowdown that led to a meaningful jump in unemployment and credit lending losses could send S&P 500 earnings down toward $200 and the index closer to the 3,000 level versus the 3,900 level today.

The market is trying to put in a summer bottom. Biotech, pharma and even some money-losing tech stocks have lifted off their floors. Managed care names seem to be ignoring the down market behind great earnings last week at United Healthcare. Even Costco is ignoring the screams at Target and Walmart and rebounding 30% in the last two months. There are pockets of strength even in an equity market that looks very highly correlated. The recent interest in high growth stocks has been interesting to see. This move signals to me that there is a part of the investment community that thinks the Fed will perfectly land this plane. This is because you certainly would not want to be anywhere near an unprofitable growth company if a 'worse slowdown' occurred. Valuations are never low enough when companies run out of capital and investors are unwilling to fund them. They just go 'poof' like Webvan did. But maybe there are some former 10-20x EV/sales valuations that are now 2-4x and worth looking into which could be causing this bounce. Plenty of valuation analysis work to be done while we wait for the economic data to pick a definite direction. And the earnings reporting firehose will swing wide open this week. Stay cool this week.


Last week's inflation numbers did little to give the FOMC any room this month...

June core CPI rose by 0.71% month-over-month, defying expectations for a deceleration and the fastest pace in a year. The breadth of core inflation increased further, with 6-month annualized inflation now above 6% for 42% of the basket. The 36-year-high rent reading poses upside risk to the path of the funds rate in the second half of the year, as shelter is one of the largest and most persistent inflation categories.

Goldman Sachs

The Daily Shot



Beyond 60/40: Allocating to Private Markets

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Will the Fed focus more on the backward-looking data or the forward-looking numbers?

After this month's hike of 75 or 100 basis points, they will have two months to sit back and see how the economy cools before their next decision.

US job vacancies rate

Some good thoughts from Abby Joseph Cohen in Barron's this weekend...

Recession, or no recession? Abby, where do you stand?

Abby Joseph Cohen: I am not in the recession camp. I don’t see the preconditions. I’m focused on the health of the labor market. We have 11 million unfilled jobs in the U.S., up from seven million prepandemic. Wages are rising. There is demand for workers. Household balance sheets are robust. We may well have a recession out there, but I don’t see it this year or in 2023.

If there is no recession, corporate profits will probably be OK. Year-on-year, the comparisons are difficult; record profit margins are coming under pressure. But taking a broader perspective, profit margins are still high in most industries. Corporate balance sheets are good, with some $4 trillion in cash. Within six to 12 months, we could see some recovery in the S&P 500, with leadership coming from different sectors.

At the start of the year, markets were priced for perfection. Valuation metrics were in the 95th percentile historically. With no margin for error, it wasn’t a surprise that equities faltered when problems arose. I didn’t think it would be a great year, but I didn’t think it was going to be as horrendous as it has turned out to be. We have had a lot of issues: the invasion of Ukraine, the ongoing shutdown in China, and a return to the old inventory cycle.

Don’t forget inflation and rate hikes.

The bond market figured it out before the Fed, as intermediate and long rates rose. Now, some of those rates have moderated. We may have seen at least a temporary peak in commodity prices. A slowing housing market might also take some of the pressure off the Fed. Cryptocurrencies have also been an issue, as has the strong dollar.

Barrons


As Q2 earnings hit, here are some of my favorite quotes...

"We're up and around Main Street U.S.A. every single day and we're watching it really closely. And it seems as though demand is quite strong -- As I mentioned earlier, I hope -- I think we'd all be better off if nobody read the news or listened to the news because it seems like we're trying to talk ourselves into it. But that being said, we're watching it really, really closely because as Mike mentioned, we'll pivot, we'll pivot appropriately. But to date, it appears as though Main Street USA is doing just fine and we're encouraged by that." - Cintas (CTAS) CEO Todd Schneider

The Transcript

"Little of the data I see tells me the U.S. is on the cusp of a recession. Consumer spending remains well above pre-COVID levels with household savings providing a cushion for future stress. And as any employer will tell you, the job market remains very tight. Similarly, our corporate clients see robust demand and healthy balance sheets with revenue softness attributed to supply chain constraints so far. So, while a recession could indeed take place over the next two years in the U.S., it's highly unlikely to be a sharper downturn as others in recent memory." - Citigroup (C) CEO Jane Fraser

The Transcript

"Leading indicators such as payment rates, deposit levels, utilization, and revolving debt trends do not yet indicate signs of stress -- Credit performance remained strong. Our allowance reflected an increase due to loan growth -- Overall, our consumer deposit customers' health indicators, including cash flow, payroll, and overdraft trends are not showing elevated risk concerns." - Wells Fargo (WFC) CEO Charlie Scharf

The Transcript

"Consumers are in good shape. They’re spending money. They have more income. Jobs are plentiful. They’re spending 10% more than last year, almost 30% plus more than pre-COVID. Businesses, you talk to them, they’re in good shape. They’re doing fine. We’ve never seen business credit be better ever like in our lifetimes. And that’s the current environment. The future environment, which is not that far off, involves rates going up, maybe more than people think because of inflation, maybe stagflation, maybe soft -- there might be a soft landing. I’m simply saying there’s a range of potential outcomes from a soft landing to a hard landing, driven by how much rates go up." - JPMorgan Chase (JPM) CEO Jamie Dimon

The Transcript


Bank of America today reported very healthy consumer credit card statistics...

Wide distribution of outcomes after historical yield curve inversions

Bank of America


Hamilton Lane’s Interactive 2022 Market Overview

Our 2022 Market Overview draws parallels between the story of King Midas and the exuberance of the private markets of late. Will the industry come to rue the gift of a golden touch? Is all that glitters really gold?

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Earnings estimates are slipping as analysts update their forward numbers...

Interestingly, stocks have stopped following the declines in future earnings. Let's see if this continues as we enter the big wave of corporate earnings.

@EarningsScout


Here is the big list of earnings to be released this week...

Best Year for Commodities

@eWhispers


Past inflation reports on the CPI and PPI worried the market last week. But Friday's forward inflation expectations gave the market a big boost...

@Schuldensuehner: This number saved the week: Long-term inflation expectations as polled by University of Michigan actually declined to 2.8% from 3.1% prev - and this measure is now down sharply from +3.3% reading that compelled the Fed to signal that it will hike rates by 75bp at its June meeting

Best Year for Commodities

It won't hurt the consumer or the shipper that gasoline prices are in freefall...

Best Year for Commodities

But consumers are also expecting unemployment to rise in the months ahead...

Best Year for Commodities

The Daily Shot


How many minutes into the FOMC meeting this month before someone brings up Monday's Apple slowing job growth?

And yes, the odds of a 75-basis point hike this month actually jumped north of 70% as this news hit the tape on Monday. Apple's stock price also fell $3.50.

Apple Inc. plans to slow hiring and spending growth next year in some divisions to cope with a potential economic downturn, according to people with knowledge of the matter.

The decision stems from a move to be more careful during uncertain times, though it isn’t a companywide policy, said the people, who asked not to be identified because the deliberations are private. The changes won’t affect all teams, and Apple is still planning an aggressive product launch schedule in 2023 that includes a mixed-reality headset, its first major new category since 2015.

Still, the more cautious tone is notable for Apple, a company that has generally beat Wall Street predictions during the Covid-19 pandemic and has weathered past economic turmoil better than many peers...

Alphabet Inc., Amazon.com Inc., Meta Platforms Inc., Snap Inc. and other tech companies have taken their own steps in recent weeks to rein in budgets and decelerate hiring. Microsoft Corp., Tesla Inc. and Meta have gone as far as to cut jobs -- something Apple hasn’t historically done.

Bloomberg


Also eliminating the need for a 100-basis point FOMC rate increase is Friday's report from the New York state...

S&P 500

The Daily Shot


Do you really have to work downtown today?

S&P 500

Visual Capitalist


Amazon and others are asking the same question as they halt new commercial development plans...

Amazon.com Inc. is pausing construction on six new office buildings in Nashville, Tenn., and Bellevue, Wash., as it redesigns workspaces for hybrid work.

The tech company said Friday that it was delaying the build-out of its traditional working floors and aiming for more social layouts.

Some companies are attempting to make their offices more appealing and collaborative for employees, particularly those who prefer working remotely more than two years into the Covid-19 pandemic.

“Like many companies, we’re still learning how these new habits may impact our office footprint,” said John Schoettler, Amazon’s vice president of global real estate and facilities.

WSJ


Not just commercial real estate builders hitting the pause button. Here is Ivy Zelman talking about residential...

Best Year for Commodities

@calculatedrisk


This week's NAHB survey shows residential builders throwing up their arms...

“Production bottlenecks, rising home building costs and high inflation are causing many builders to halt construction because the cost of land, construction and financing exceeds the market value of the home,” said NAHB Chairman Jerry Konter, a home builder and developer from Savannah, Ga. “In another sign of a softening market, 13% of builders in the HMI survey reported reducing home prices in the past month to bolster sales and/or limit cancellations.”

Best Year for Commodities

NAHB


A slowdown in the home buying market should be music to the ears of apartment owners...

Skyrocketing home prices and mortgage rates make this a tough time to buy a house. But it’s an opportunity for bargain hunters to invest in apartment real estate investment trusts, which have been clobbered this year and are down about 20% despite surging rents.

“Looking back over the past decade or so, opportunities to buy shares of blue-chip apartment REIT stocks have been few and far between,” says Brad Thomas, CEO and senior analyst at Wide Moat Research and author of The Intelligent REIT Investor. “There is a rare sale going on right now.” Apartment REITs are currently trading at a 21% discount to the value of their underlying assets, calculates Green Street, a commercial real estate analytics firm. As recently as a year ago, they were trading at a 3% discount.

It isn’t surprising that apartment REITs have tumbled along with stocks and bonds this year in a broad market selloff. Real estate investments are sensitive to interest rates, which raise borrowing costs...

But high rates are actually good news for apartment REITs, since they make buying a home more difficult. After a period of record-low mortgage rates, the 30-year fixed rate has nearly doubled to 5.51%. In May, the median existing-home sales price topped $400,000 for the first time, further straining affordability.

“There are some would-be buyers who are now pushed into the rentership pool,” says Haendel St. Juste, managing director and REITs analyst at Mizuho Securities. “The dramatic shift in the cost of homeownership is a net benefit for the rental side.”

Analysts say the selloff in apartment REITs appears to be overdone, given that the companies have healthy balance sheets and the outlook for rental demand looks strong. The latest consumer-price-index report showed that rent prices had climbed by the most since 1986—up 5.8% from a year earlier.

Barrons


Taiwan Semi said last week that consumer chips are now in adequate supply...

"On the inventory side, due to the softening device momentum in smartphone, PC, and consumer end market segments, we observe the supply chain is already taking action and expect inventory level to reduce throughout the second half of 2022. After 2 years of pandemic-driven stay-to-home demand, this type of adjustment is reasonable, in our view. Our expectation is for the excess inventory in the semiconductor supply chain to take a few quarters to rebalance to a healthier level -- The inventory correction maybe go for a few quarters, through the first half of 2023. It's not like a big down cycle back in 2008 or something like that." - Taiwan Semiconductor Manufacturing (TSM) CEO C. C. Wei

The Transcript


Warren and Charlie clearly have a strong opinion on the outlook for the U.S. energy industry...

Berkshire Hathaway continues to buy OXY in the open market on a weekly basis and is nearing a 20% ownership. Maybe an important time to review why they helped OXY buy Anadarko which jumpstarted their stake.

“I would think if you owned Occidental, you’re bullish on oil over the years – and you’re probably bullish on the Permian Basin because they have such a significant portion of their assets there. So, the idea that they will use less stock and more cash as part of the deal… I would think, net, if I had been an OXY holder at the time, I probably would like that kind of a deal… It’s a bet on oil prices over the long-term more than anything else. It’s also a bet the Permian Basin is what it’s cracked up to be… If oil goes way up, you make a lot of money… You have to have a view on oil over time. Charlie and I have some views on that… We feel good about doing the financing.”

Best Year for Commodities

The Science of Hitting


If this market pull back is not joined by a credit crisis, then it is probably time to start sizing up your BUY list...

@mark_ungewitter: Breadth washouts usually attend cyclical bottoms, but can also occur in early stages of secular bear markets. June’s washout warrants incremental exposure, in my opinion, though full allocation is not yet justified.

S&P 500

More fuel for the fire if equity managers get caught short in a second half upward rip...

@GunjanJS: Equity futures positioning for asset managers and leveraged funds is now the **most short** on RECORD -DB

S&P 500

Bank of America's valuation chart to pick your downside target with...

I would look to buy a much bigger wheelbarrow at 15x $200 also.

S&P 500

BofA Global


If you are digging into global valuations, Dr. Damodaran's updated Earnings Risk Premium by country may be helpful...

@AswathDamodaran: As we all look outside domestic markets for returns, understanding why risk varies across countries and how to measure it becomes a key. My 2022 mid-year update for country risk is up.
Paper: https://bit.ly/3yCWGRL Post: https://bit.ly/3c7IDvY Data: https://bit.ly/3Od3o6Y

S&P 500

If making $250 for fifteen minutes is worth your time, then give the U.S. Series I Savings Bonds a look...

I saw two months ago where the U.S. Treasury popped the annualized rate of the I-Series bonds to 9.62%. But with a limit of $10,000 per person and all the negative stories about the clunky website and process to buy, I decided against bringing the item to your attention. But after receiving so many questions about I-bonds over the last two months, I sat down yesterday to give the purchase a try. To my great surprise, I think that I clocked in at 14 minutes from start to purchase and stuck $10,000 I-Bonds into my Treasury Direct wallet. The process would have been faster had I not flubbed my three security questions. Wasn't Tom Brady, Crypto & Matt Damon the correct response?

So, I figure that the I-bonds 9.62% interest rate will get cut in half in 6 months. But even with this slice, the excess 500 basis points over my current conservative allocation in preferred stocks or corporate bonds would earn an excess of $250 in the next half year (and risk free!). So, grab your spouse and two laptops and make a race of it to pay for a few nice dinners this month. Then forget about the bonds and keep them stashed as emergency money or a future gift for yourself when inflation falls back below 2%. Below is the the FAQ from the WSJ about U.S. Treasury I-Bonds.

A popular investment backed by the U.S. government recently became even more attractive, especially for tax-smart investors who are worried about inflation.

I wrote about the tax advantages and other aspects of Series I savings bonds in a column earlier this year. That column garnered a lot of follow-up questions from Wall Street Journal readers. The popularity of these investments is likely to continue with the U.S. Treasury announcing a few weeks ago that the initial annualized rate on new Series I savings bonds sold from May through October of this year is 9.62%.

To be sure, no investment is perfect for everyone. But series I bonds have so many attractive features that they represent an “absolutely superb” investment opportunity, says Burton Malkiel, author of the investment classic “A Random Walk Down Wall Street.”

So then, here are answers to some of those reader questions as well as other queries that investors may have about the bonds...

WSJ


Costco's $1.50 hotdog combo lunch story never gets old...

If the price of the hot dog combo kept up with the rate of inflation, it would cost about $4.13 today, according to the Bureau of Labor Statistics. The cost of hot dogs was up 16% at the end of June, compared with a year ago, according to BLS data...

At a 2018 luncheon, Costco Chief Executive W. Craig Jelinek recounted how he once told the company’s co-founder Jim Sinegal they needed to raise the price of hot dogs.

“I said, ‘Jim, we can’t sell this hot dog for a buck fifty,’” Mr. Jelinek said. “‘We are losing our rear ends.’ And he said, ‘If you raise the effing hot dog, I will kill you. Figure it out.’ That’s all I really needed.”...

Costco’s CFO wouldn’t directly say whether food court items were loss leaders.

“Needless to say we aren’t making a lot or any” money on the food courts, Mr. Galanti said. “At the end of the day, the whole value of our warehouse club includes a great value on that hot dog and soda.”

The hot dog combo brings in Costco fans like Santiago Almeida, who said he eats a hot dog from the retailer about every other week. He said the combo is one of his go-to dinner options to feed his 6-year-old son, who can be picky about what he eats.

“We go to Costco just to have a hot dog,” said Mr. Almeida, a 48-year-old lawyer from Charleston, S.C. “You can’t beat the price.”

WSJ

S&P 500

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DISCLOSURES

The author has current equity ownership in: Costco Wholesale Co. & J.P. Morgan Chase & Co.

The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, Hamilton Lane is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of Hamilton Lane.

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