Private Wealth

Weekly Research Briefing: The Light at the End of the Tunnel

September 27, 2022

You can see the light at the end, but how much risk will you take to run down to the other end? Big returns await if you can only make it to the other side. But there is always the possibility that you make it part way and the train called 'recession' interrupts your path. With the FOMC staying on its high-rate hike path and raising the 2023 average terminal dot plot to above 4.5%, not only have the odds of peak inflation risen, but so have the odds of a policy mistake leading to a greater-than-expected slowdown. Right now, the labor economy looks to be in fine shape. But what will it look like after another 150 basis points in hikes? The unemployment rate will rise as the economy slows. But will it rise from the mid-3's to the mid-4's or mid-5's? We just don't know right now. On top of our uncertainty in fighting inflation in the U.S., the Europeans are attempting to do the same while Putin disrupts the energy markets, the U.K. is embarking on an unpopular financial plan, Iran has unleashed social unrest across all of its social and economic layers, and hurricane Ian is lining up the Gulf of Mexico and Florida. With the VIX above 30 and the S&P 500 closing at a new 2022 low today, do you still want to run through that tunnel?

Speaking of volatility, Bespoke Investment noted last week that 25% of all trading days so far this year have been declines of 1%+. The only other post-WWII years with a higher frequency were 1974 (26.6%), 2002 (28.6%), and 2008 (29.6%). So, if misery loves company, then this could be the bottoming year. With so many issues causing major uncertainty in the financial markets, could we be near a turning point? Could the Fed pivot? Could Putin admit defeat? Could Iran retire its morality police? Could the U.K. stop devaluing itself? Or could the sellers just become exhausted? As it stands now, it looks difficult to want to buy dump trucks full of equities until the 2-year Treasury Yield stops rising. With risk free assets yielding 4% and many higher quality bonds yielding in the high single digits, there seems to be too much competition for equities right now. That could all change when interest rates follow inflation lower, but we aren't there yet.

Corporate earnings will begin in two weeks. Stocks are down going into the numbers which means that earnings expectations are being lowered. We had this setup three months ago and stocks bounced 10-20% on their mediocre results. This earnings season could get even more interesting if the market applauds uneventful earnings at the same time that the year-end seasonal strength kicks in. Of course, this time, the companies will need to address rising interest rates, higher costs and a potentially slowing economy. Better plan for longer earnings conference calls.

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The FOMC dots did not inspire confidence in the risk markets last week...


- Raises Median forecast for end-2022 rate 4.375% (prior 3.375%)

- Raises Median forecast for end-2023 rate 4.625% (prior 3.75%) above what fed fund futures had been pricing in

- Raises Median forecast for end-2024 rate 3.875% (prior 3.375%)

- Targets Median forecast for end-2025 rate 2.875% (initial projection)


Wells Fargo

The Fed Funds rate is rising at its fastest pace ever...


The market has quickly moved to follow the dots and suggests a 4.50% Fed Funds rate in February 2023...

CME Group

The Fed's top goal is to fight inflation, so here is a good road map on how the CPI falls back to 2%...

@bespokeinvest: Here's an update of our table that shows the forward path for YoY CPI based on constant MoM prints between -0.1% and +0.4%.

Forward market rates always overshoot the top Fed Funds rate. Now where will this cycle's estimated terminal rate peak?

@LizAnnSonders: Market says “higher” … orange line shows highest projected terminal fed funds rate based on contracts out 10 months; blue is actual fed funds rate … spread has varied at times, but market has generally done OK job of seeing where rate ultimately landed. @biancoresearch

Just like Fed Chair Powell said at Jackson Hole, this is all about taking care of inflation first...

Federal Reserve Chair Jerome Powell:

  • “I want to start here today by saying that my main message has not changed at all since Jackson Hole. The FOMC is strongly resolved to bring inflation down to 2%, and we will keep at it until the job is done. So the way we’re thinking about this is the overarching focus of the committee is getting inflation back down to 2%”
  • "We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t. So what we need to do is get rates up to the point where we’re putting meaningful downward pressure on inflation, and that’s what we’re doing. And we certainly don’t hope – we certainly haven’t given up the idea that we can have a relatively modest increase in unemployment. Nonetheless, we need to complete this task”

The Transcript

The Fed is willing to sacrifice some of the labor market to get what it wants. Here is the new unemployment rate projection...

Wells Fargo

Job losses are coming next year, according to Bank of America...

So, if unemployment data goes under watch for higher digits, so should company bankruptcies...


Onto the impact on equities, the continued increase in risk-free rates have become too much of a hurdle for stock valuations...

Goldman Sachs

Wells Fargo throws in the towel on stocks...

And Goldman Sachs also revises its data down to show little upside in U.S. equities...

Our central market view has been that until the economy either enters a clear recession or shows sustained signs of progress on inflation, the pressure for tighter financial conditions is unlikely to abate and periods of relief are unlikely to be sustained. Markets began getting more comfortable with the inflation trajectory back in July when CPI came in well-below expectations. But now, it may take more than a below-expectations PCE report since the Fed has now indicated a greater commitment to sustainably taming inflation -- as well as a willingness to allow unemployment to rise in that effort...

The principle driver behind our lower S&P 500 target is the rapid move higher that we have seen in real rates (as captured by the yield on 10-year TIPS bonds). And since 2016, the forward P/E multiple of the S&P 500 has tracked remarkably closely with movements in real rates. Lately, in fact, real rates have risen even more sharply than the stock market has fallen, suggesting that should the difference between 10-year Treasury yields and long-term inflation expectations (as captured by TIPS markets) remain elevated as it is now, we could see more downward pressure on stock valuations -- fueling our 3600 near-term target for the S&P 500.

Goldman Sachs


Morgan Stanley was already very cautious on stocks and remains so...

Morgan Stanley

J.P. Morgan notes the potential silver linings...

Fed hawkishness leaves stocks very oversold: The global inflation trajectory is becoming even more central for tactical asset allocation and it could keep volatility elevated until the next set of CPI releases. However, we note some encouraging signs on the inflation front given declining core goods as supply chains normalize further and the strong dollar puts downward pressure on input prices, lower Energy prices, and falling leading indicators on rents. Meanwhile, some pre-conditions for a market bottom are falling into place: stocks are looking increasingly cheap and approaching deep-value outside of the US, and positioning is extremely depressed.

J.P. Morgan

Volatility will help make the bottom, at some point...

Volatility… the only years with higher volatility in stocks at this point than 2022 (178 trading days):

  • 1930s (Great Depression, World War II)
  • 2002 (Dot-Com Crash)
  • 2009 (Global Financial Crisis)
  • 2020 (Covid Crash)

Jones Trading

Individual investors have thrown in the towel...

No word on meme stock day traders.

The Daily Shot

Buy-the-dip is dead...

It is the worst year for buying the stock-market dip since the 1930s.

Instead of rebounding after a tumble, stocks have continued to fall, burning investors who stepped in to buy shares on sale. The S&P 500 has dropped 1.2% on average this year in the week after a one-day loss of at least 1%, according to Dow Jones Market Data. That is the biggest such decline since 1931.

The extended downturn is putting a dent in the popular buy-the-dip trade, a strategy in which many investors found great success after the last financial crisis and particularly during the lightning-fast pandemic recovery.


Contrarian alert?

@Barchart: More than 33 million puts traded on Friday, the highest single day of put volume since data began to be collected roughly 30 years ago.

The Fed seems to be getting the signals that it wants from the economy to slow inflation...

“The U.S. economy has slowed from the historically high growth rates of 2021, which reflected the reopening of the economy following the pandemic recession. Recent indicators point to modest growth of spending and production. Growth in consumer spending has slowed from last year’s rapid pace, in part reflecting lower real disposable income and tighter financial conditions. Activity in the housing sector has weakened significantly, in large part reflecting higher mortgage rates. Higher interest rates and slower output growth also appear to be weighing on business fixed investment, while weaker economic growth abroad is restraining exports” - Federal Reserve Chair Jerome Powell

The Transcript

Broad feedback from the flood of consumer product and retail companies to visit investors over the last few weeks show mostly positive trends...

Consumer/Retail CEOs remain “tempered” on 2H22 expectations tied to the broader macroeconomic environment w/ top-line moderation in June mirroring the US Consumer Sentiment trough on peak inflation pressures (Food +10.9% & Gas Prices nearly $5 per gallon on average), and personal savings rates cut nearly in half relative to levels exiting 2021 (5% in July ’22 vs. 8.7% in Dec ’21). That said, nearly every company across our coverage cited signs of “improvement” in August (relative to the June trough) as a return from summer travel (& early BTS) drove a spending catalyst w/ our Chase Discretionary Credit Card data accelerating ~400bps to date relative to the June trough noting $1 or 20% decline in gas prices to ~$3.80 per gallon.

J.P. Morgan

No slowdown in consumer cosmetic & fragrance...

COTY (Coty) is raising guidance for FQ1/Sept due to stronger beauty demand and now sees LFL sales growth of +8-9% (vs. the prior +6-8%). “The improved outlook is being fueled by both Prestige and Consumer Beauty, and across Europe, the Americas, and Global Travel Retail. The strong sales momentum also underpins a stronger Q1 gross margin outlook, despite continued inflationary pressures”.

Vital Knowledge

The cereal business also looks solid...

GIS (General Mills) reported solid FQ1/Aug results and they raised the full-year guidance (this print is a bit better than it appears given some worry about disappointment given the cautious tone from the industry at the recent Barclays staples conf.). Revs came in up 10% organic (this is about 150bp ahead of the St) w/EPS of 1.11 (this is 10c higher than the St consensus). The 10% organic growth breaks down to 15% from price and neg. 5% volumes. North American Retail organic growth was 12% (double the St) while Food Service did extremely well at 18% (the St was modeling growth of only 3%) and Pet fell a touch short at 14% organic growth (vs. the St 17.5%). Adjusted gross margin was up 20 basis points to 34.9 percent of net sales (this is solidly above the 33.1% forecast by investors). Adjusted operating profit margin increased 70 basis points to 18.7 percent. They now see full-year revs up 6-7% organic (vs. the prior 4-5%) w/constant currency adjusted EPS up 2-5% (vs. the prior flat-to-up 3%).

Vital Knowledge

Costco talks 'a little light at the end of the tunnel' on higher prices and costs...

"We've seen minor improvement in a few areas. But all in, pressures from higher commodity prices, higher wages and higher transportation costs and supply chain disruptions. They're still present, but we are seeing just a little light at the end of the tunnel. And if you recall in the third quarter, we indicated that price inflation overall was about 7% plus for us. For the fourth quarter and talking with our merchants, the estimated price inflation overall was about 8%, a little higher on the food and sundries side, a little lower on fresh foods, and both higher and lower on the nonfood side. We're seeing commodities -- some commodities prices coming down, such as gas, steel, beef, relative to a year ago, even some small cost changes in plastics. We're seeing some relief on container pricing. Wages are still the higher thing when we talk to our suppliers. And as we all know, wages still seem to be the one thing that's still relatively higher. But overall, some beginnings of some light at the end of that tunnel. And of course, that could change each week." - Costco CFO Richard Galanti

The Transcript

Las Vegas sounds great...

"So let's talk a little bit about what we're seeing in our markets. First of all, in the Las Vegas strip, business has really never been stronger in Las Vegas than it is right now. In the second quarter, we set all-time records in our Las Vegas properties -- Very strong also across virtually all customer segments. In the second quarter, we saw groups beginning to come back and now in the third quarter and looking into the fourth quarter." - MGM Resorts CFO Jonathan Halkyard

The Transcript

Too much stress in office furniture so cutting the dividend...

Steelcase - “Due to the recent volume decline in our incoming orders (orders through the first three weeks of the third quarter declined approximately 20% compared to the prior year) and lower than expected return-to-office trends in the Americas, we are planning to implement additional actions in the third quarter which target further reduction of our planned level of spending. These actions target approximately $20 million of annualized spending and are expected to include the elimination of up to 180 salaried positions across the Americas core business and Corporate functions”.


Less need for office furniture and workers in the metaverse...

Meta Platforms Inc. is planning to cut expenses by at least 10% in the coming months, in part through staff reductions, as the social-media giant confronts stalling growth and increased competition, according to people familiar with the company’s plans.

The Menlo Park, Calif., company has begun quietly nudging out a significant number of staffers by reorganizing departments and giving affected employees a limited window to apply for other roles within the company, according to current and former managers familiar with the matter, in a move that achieves staffing cuts while forestalling the mass issuance of pink slips.

The reductions are expected to be a prelude to deeper cuts, according to people informed of the company’s plans. While some savings will come from cuts to overhead and consulting budgets, the people said, much of it is expected to come from reduced employment.


Ford was one of the bigger pre-announcement letdowns last week as supplier issues continue to impact...

[F] Guides Q3 adj EBIT $1.4-1.7B, anticipates inflation related supply costs of $1.0B above plan; Affirms FY22 adj EBIT outlook of $11.5-$12.5B

- Expects 40-45K vehicles in inventory at end of Q3 due to lack of certain parts presently in short supply; To push sales of these vehicles to Q4

- Says “vehicles on wheels” awaiting those parts disproportionately include high-demand, high-margin models of popular trucks and SUVs

- Advises that completing such vehicles will shift some revenue and EBIT to Q4; based on recent negotiations, inflation-related Q3 supply costs will be ~$1.0 billion above plan

- Anticipates Q3 adjusted EBIT of between $1.4B and $1.7B - The supply shortages will result in a higher-than-planned number of “vehicles on wheels” built but remaining in Ford’s inventory awaiting needed parts, at the end of the third quarter. The company believes that those vehicles – an anticipated 40,000 to 45,000 of them, largely high-margin trucks and SUVs – will be completed and sold to dealers during the fourth quarter.

- According to the company, based on recent negotiations, inflation-related supplier costs during the third quarter will run about $1.0B higher than originally expected.


And Olin continues the string of weak chemical company pre-announcements...

[OLN] Reports prelim Q3 adj EBITDA $530-550M v $727M y/y on accelerated deterioration in European and North American demand CEO: "We have seen global economic conditions worsen faster than expected with an accelerated deterioration in both European and North American demand particularly in epoxy and vinyls intermediates, which has been aggravated by increased Chinese exports precipitated by continuing weak Chinese domestic demand. Winchester experienced lower than expected commercial ammunition volumes as customers' supply chain inventories were overfilled across some ammunition calibers. Olin proactively further reduced our participation in these weaker markets and increased our purchases of global product liquidity. Olin's proactive actions and strategy have us well-positioned with a strong balance sheet, meaningful levered free cash flow, and solid positive earnings profile, to deliver on our previously anticipated recession scenario results in fourth quarter 2022 and continuing into 2023. Core electrochemical unit (ECU) pricing for merchant chlorine and caustic soda continues to move higher."


Another headwind for U.S. corporations will be negative currency impacts on their foreign sales...

@FerroTV: G10 vs USD this year. Brutal.

New home sales implode as orders fall 50% at KB Home and 12% at Lennar...

KB Homes - “Reflecting lower demand stemming from higher mortgage interest rates, inflation and various other macroeconomic and geopolitical concerns, net orders of 2,040 and net order value of $979.0 million decreased 50% and 51%, respectively”.

“The long-term outlook for the housing market remains favorable. However, the combination of rising mortgage interest rates, ongoing inflation and other macro concerns has caused many prospective buyers to pause on their homebuying decision. We are being more selective with respect to land investments, as reflected in our significantly lower spend in the third quarter”.

Lennar - “Sales have clearly been impacted by rising interest rates, but there remains a significant national shortage of housing, especially workforce housing, and demand remains strong as we navigate the rebalance between price and interest rates. Our cycle time during the quarter was marginally down sequentially, indicating that the well documented supply chain issues that continue to limit our productivity are beginning to become more manageable and perhaps subside”.

Jones Trading

Following the lack of new home orders is the price of lumber...

@thedailyshot: US lumber prices are falling as the housing market comes under pressure.

Even luxury home sales are now waning...

A new report by real-estate brokerage Redfin shows that in the three months ending Aug. 31, sales of luxury U.S. homes dropped 28.1%, from the same period last year. That marks the biggest decline since at least 2012, when Redfin’s records began, and eclipses even the 23.2% decrease recorded during the onslaught of the pandemic in 2020, the report said.

Sales of nonluxury homes also fell during the same period, but that drop—19.5%– was smaller than the decline in the luxury market, which is defined as the top 5% of homes based on estimated market value, according to Redfin...

High-end California markets have seen some of the steepest declines in sales volume, Redfin’s data shows. The number of home sales plunged by close to 64% in Oakland, Calif., while San Jose and San Diego also posted decreases of more than 55%. The number of home sales fell 44.3% in Los Angeles, 55.5% in Miami and 11.8% in New York...

While the volume of luxury sales across the country has dipped dramatically, prices are still holding firm, though their growth has slowed. The median sale price of a U.S. luxury home grew 10.5% to $1.1 million during the three months ending Aug. 31, according to Redfin, compared with a 20.3% increase during the same period of last year. Ms. Fairweather said she expects prices to decline throughout the winter.


A good interview with John Paulson on why this housing pullback will be unlikely to cause a crisis like the last one did...

Well the financial market, the banking system and the housing market are much different today than in ‘06 and ‘07. The underlying quality of the mortgages today is far superior. You don’t even have any subprime mortgages in the market … And the FICO scores are very, very high. The average is like 760. And the subprime, they were averaging 580-620 with no down payment. So in that period, there was no down payments, no credit checks, very high leverage. And it’s just the opposite of what’s happening today. So you don’t have the degree of poor credit quality in mortgages that you did at that time.

The other factor is the banks at that period were very highly leveraged. The average capital in your major banks was about 3%. And then they had a lot of off-balance sheet exposure as well. So, you know, it doesn’t take a lot to fail if you have, let’s say, a hundred dollars in assets, and then on the liability side you only have $3 in equity and $97 in various types of borrowing. If you’re not really careful on the asset side, all the assets have to do is fall 3% and your equity is wiped out. You go into default. So the problem, in that period of time, the banks were very speculative about what they were investing in. They had a lot of risky subprime, high yield, levered loans. And when the market started to fall, the equity quickly came under pressure.

And it caused the failure, very quickly, of major financial institutions in the US ... The banks have recovered. But as a condition going forward, they really raise the equity. Today, the average bank is probably 9% equity, the systemically important banks are 11%-12% equity. So almost between three and four times as much equity as before. So we’re not at risk of a collapse today in the financial system like we were before. Yeah, it’s true, housing may be a little frothy. So housing prices may come down or they may plateau, but not to the extent it happened.


Manhattan rental pricing has also begun to retreat...

Manhattan’s hot rental market ended its six-month streak of record-setting prices in August, as rates fell slightly from the month before.

New leases were signed at a median of $4,100, down $50 from July’s all-time high, according to a report Thursday by appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate. The price dip came during the market’s busiest month of the year, with more than 5,800 deals inked in August, a nearly 10% increase over July’s volume.

“Rents are robust but they are starting to plateau,” said Jonathan Miller, president of Miller Samuel. He doesn’t expect costs to drop significantly unless the labor market shifts, cutting off the flow of new hires into the city and making it harder for current apartment dwellers to pay their bills.


And not just Manhattan, but apartment prices across the nation are now moving lower...

Apartment rents are falling from record highs across the U.S. for the first time in nearly two years, offering the prospect of relief to millions of tenants who have seen steep increases during the pandemic.

August apartment asking rents nationally fell 0.1% from July, according to a report from property data company CoStar Group. It was the first monthly decline in rent since December 2020, the company said.

Other surveys also showed rent declines of various degrees. Apartment-listing website showed a 2.8% decrease in rent for one-bedroom apartments during the same month. A third measure, by the listings website, also noted a slight monthly decline in rent this August...

Any substantial relief for cost-burdened renters is still a ways off, however. Most apartment tenants have signed one- or two-year leases at a fixed monthly price. The lag between today’s market rental prices and what most tenants actually pay is also part of why housing costs, as tracked in the Bureau of Labor Statistics’ consumer-price index, are still shown to be rising.

If the rental market continues to soften, falling rents should become more apparent in official inflation figures some time in 2023, said Jay Parsons, a housing economist at rental software company RealPage.

Investors are also taking cues from the most recent reports on market rents, rather than headline inflation. “The pace of rent increases, we’re seeing it go down month-to-month,” said Barry Sternlicht, chief executive of the investment firm Starwood Capital Group, in a recent CNBC interview. Starwood is one of the largest owners of multifamily units in the U.S.


Now we just need the lower rental pricing to cycle through to the CPI...

@MikeZaccardi: Goldman: The CPI Is Skewed Towards Urban Apartments, and the Rent Catch-up in High-Density Zip Codes Appears to Have Run Its Course

REITs used to offer a yield advantage over fixed income securities...


But not just REITs, but all dividend paying equities are now seeing competition from bonds and risk free interest rates...


The inflation protection asset that didn't protect...

@hmeisler: GLD says what inflation?

Private market asset values for August hit the books last week...

Checking in on my private asset vehicle for its last reporting period in August shows more solid returns for my core ballast during this volatile time in the public markets.

S&P Capital IQ and Hamilton Lane

I get the impression that the CEO of Snowflake doesn't like being a public company...

Let's see if the company continues to be a standalone company in 2023 in the event that technology or software valuations take another digger into year end.

"...if you want to get out in 90 days and make a bunch of money, I have nothing to tell you -- We’re making sizable acquisitions. We give 10-year guidance. Why? Because we don’t want people to pick the fly shit out of the pepper, so to speak, and you have my opaque views of the quarter. But say, look, is your thesis intact over the long period of time. And those are always the questions that we try and answer. I cannot run a company on a quarterly basis. There are quarterly aspects to it. Fundamentally, almost everything that we do has a much longer time horizon. When you look at P&Ls, most of the money we spend is not related to the current period, right? And sometimes it’s hard to convey that." - Snowflake CEO Frank Slootman

The Transcript

And you know that they are watching our every move...

A new estimate for the total number of ants burrowing and buzzing on Earth comes to a whopping total of nearly 20 quadrillion individuals.

That staggering sum — 20,000,000,000,000,000, or 20,000 trillion — reveals ants’ astonishing ubiquity even as scientists grow concerned a possible mass die off of insects could upend ecosystems.

In a paper released Monday by the Proceedings of the National Academy of Sciences, a group of scientists from the University of Hong Kong analyzed 489 studies and concluded that the total mass of ants on Earth weighs in at about 12 megatons of dry carbon, a standard way of measuring animals’ biomass.

Put another way: If all the ants were plucked from the ground and put on a scale, they would outweigh all the wild birds and mammals put together. For every person, there are about 2.5 million ants.

Washington Post

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The author has current equity ownership in: Costco Inc.

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