TQI Weekly - Issue #11: "Don't Fight The FED" Goes Out Of The Window In A Tipsy-Topsy Week
Mr. Market is fighting the FED right now. With bonds, stocks, and the FED out of sync, something has to give! What gives? Read on to find out.
Hello, and welcome to the 11th issue of The Quantamental Investor’s Weekly Newsletter series.
TQI Weekly will bring you up to speed on weekly market action, provide you with new investment ideas & research, and share portfolio strategies & investing best practices to help you build a robust investing operation.
Please feel free to share feedback with me at "the.quantamental.investor@gmail.com".
Market Round-Up
After a pleasantly uneventful end to 2022, the New Year kicked off with a tipsy-topsy week, in which all major equity indices managed to eke out small gains. In the week gone by, we saw a good deal of economic data flow in, but employment data was top and center of attention.
While the market had been lower by ~1% for the most part of the week, a rally on Friday led to a +1% weekly gain, as you can see above. This rally happened after a “Goldilocks” job report on Friday showed a beat on job additions, a lower unemployment rate, and moderation in wage growth for December.
My immediate thoughts after the jobs numbers were published in an SA News report:
Today's non-farm payrolls report was once again hotter-than-expected, with the US economy adding 223K jobs vs. est. of 200K. The unemployment rate dropped to 3.5% from 3.7% in November, indicating a tight labor market. On a positive note, average hourly earnings went up only +4.6% y/y (+0.3% m/m) in December [vs. est. +5.0% y/y], and labor force participation increased to 62.3%. If wage growth continues to moderate, the ongoing fears of a wage-price spiral pushing inflation higher are likely to be unwarranted. Overall, the labor market remains tight, and the effects of the FED's aggressive monetary policy tightening are still not visible in employment data. The market reaction to this report is likely to be neutral, and all eyes will now turn to next week's CPI inflation report.
Source: Dec. jobs growth beats forecast but slows M/M, unemployment falls to 3.5%.
Given recent market action, I believed Mr. Market’s reaction to this report would be neutral; however, broad equity markets just took off and rallied by ~2-2.7%.
Amidst this stunning move in stocks, we also saw a continuation of a rally in bonds (prices moving up, yields moving lower). The 10-yr treasury yield started 2023 at ~3.9%, and in just a week, this yield has moved down to 3.56%. This is a big move!
The 10yr/3mo spread (also known as the recession spread) is now deeply negative and points towards an imminent recession. While the bond rally is indicative of a risk-off environment, the bond market is essentially fighting the FED, which is still looking to tighten financial conditions further to reign in inflation.
The bond market is screaming - “Recession Ahead”, but the stock market is not ready to accept that reality. Yes, stocks had a bad year in 2022; however, the S&P500 is still trading at a forward P/E of ~18x (well above the mean of ~16x), and the earnings themselves are far from certain. While Friday's jobs report was a positive one, a FED pivot is not forthcoming, and the odds of the FED sleepwalking us into a recession are still very high.
Looking at the chart, I think SPY 0.00%↑ is set for an immediate re-test of the upper trendline and 200-DMA at ~394-400. This is the level I will be watching for next week. In the previous edition of TQI Weekly, I laid out my market outlook for the first half of 2023. We’re heading into a tricky Q4 earnings season, and I urge investors to remain cautious as guidance for 2023 may finally trigger earnings revisions to the downside from the sell-side analysts on Wall Street.
All the incoming economic data so far has shown resilience (barring inflation), and I think it is fine to hope for a goldilocks scenario where - inflation goes away, and we have no recession in 2023. Is this possible? I don't think so. Leading economic indicators point to a recession, and so does the bond market. Even if we avoid an economic recession, a low to no growth environment should force moderation in asset prices since discount rates are far higher now.
In Friday's session, both bonds and equities jumped up in a counterintuitive move. Either the bond market is wrong, or the stock market is wrong. At this point, both bond and stock markets are fighting the FED. And a very simple investing rule is that "DON’T FIGHT THE FED"!
What's Ahead...
January 12, 2023 (Thursday): The consumer price report will be released on Thursday, with expectations for the headline CPI reading for December to cool to +6.7% y/y from +7.1% y/y in November and be up +0.1% m/m. Core CPI is forecast to be up +5.6% y/y and +0.2% m/m. According to Bank of America, both core goods and energy prices will show further declines in December; however, food and core services inflation is set to remain elevated.
All week: Notable companies like JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), Blackrock (BLK), Citigroup (C), Bank of New York (BK), and Delta Air Lines (DAL) to report their Q4 earnings.
TQI's Latest Research
We find ourselves in a bear market, but that doesn't mean we stop researching for opportunities to make money. Over the last week, I published three research notes, and here's a summary for your perusal:
1)Tesla Stock: Q4 Delivery Disappointment, Reverse DCF Analysis, Technical Typhoon, And More
In this note, I discussed Tesla's disappointing Q4 production and delivery report. Furthermore, I performed a reverse DCF analysis to determine the implied growth rate of Tesla's current stock price. Additionally, I reviewed Tesla's technical charts and absolute valuation.
Despite near-term downside risk, Tesla is a high-quality business that I want to own for the long haul. I continue to remain bullish on Tesla’s stock; however, I have a strong preference for slow accumulation due to a precarious technical setup.
You can access the detailed article at Tesla Stock: Q4 Delivery Disappointment, Reverse DCF Analysis, Technical Typhoon, And More
2) TQI's Earnings Analysis Series Issue No. 1: Zoom
Ahead of the Q4 earnings season, I have launched a new earnings analysis series within my marketplace service. In the first issue, I discussed the state of cloud software stocks and focused on analyzing Zoom's Q3 2022 earnings report.
Paywalled article at TQI's Earnings Analysis Series Issue No. 1: Zoom.
3) TQI's Earnings Analysis Series Issue No. 1: Snowflake, Cloudflare, and Datadog
In the 2nd edition of TQI's Earnings Analysis series, we discussed Q3 earning reports from three cloud infrastructure companies - Snowflake, Datadog, and Cloudflare. In this note, we previewed Q4 reports for all three of these companies, analyzed their technical charts, and determined their fair values & expected returns to make informed investment decisions.
To find out what we are doing with these stocks, visit TQI's Earnings Analysis Series Issue No. 2: Snowflake, Cloudflare, and Datadog.
Investing Best Practice Tip
Before you go, take this piece of investing wisdom from Warren Buffet (one of the greatest investors of all time) and internalize it. In one of his Squawk Box interviews with CNBC, he said-
Do not borrow money to invest. My partner Charlie Munger says there are only three ways a smart person can go broke: liquor, ladies, and leverage
All equity investors must avoid buying stocks on borrowed money. There’s nothing worse in investing than being margin called on your equities when they are down in the dumps. Say No To Leverage!
Final Thoughts
With macroeconomic uncertainty set to persist in 2023, we could continue to see wild swings in the stock and bond markets in the upcoming weeks and months.
Be Careful. Manage Risk.
As I said in the previous issue of TQI Weekly -
I don't know where the market is going next; nobody does. At TQI, we pursue bold, active investing with proactive risk management. After a painful 2022, we may or may not see a stock market crash or recovery this year, but whatever the market does, we are prepared, and our portfolios are positioned to win in 2023.
If you want access to TQI's exclusive research and portfolio strategies, please consider joining The Quantamental Investor.
Also, if you have any questions, thoughts, and/or
concerns, please share them in the comments section.
Thank you for reading; I hope you enjoyed this issue. See you next time!