Given a demonstrable deceleration in various measures of economic activity over the past month, it’s notable that equities managed to go against the grain.
Both domestic and global stocks rose in three of the last five weeks, despite a chorus of recession warnings, which crescendoed when flash PMIs for July suggested economic activity in the US and Europe is contracting.
Some of the stabilization in equities is likely attributable to an all too familiar “bad news is good news” dynamic vis-à-vis Fed policy. Market pricing for the terminal rate has come in materially and the 2s10s inversion remains more than 20bps deep. When taken with a decline in measures of longer-term inflation expectations, stocks are getting some support from the notion that the Fed won’t make it too far into restrictive territory, either because the economy won’t let them or because inflation moderates enough to give the Committee some plausible deniability for a deescalation.
Beyond that, though, positioning was very light. “Nobody had it on,” as Nomura’s Charlie McElligott put it. “Everybody’s ‘low risk’ tilt had them with no portfolio ‘beta to beta’ on the move,” he said.
“‘Trading firm despite calamity’ matters,” Charlie added. The market “is acting very differently from prior ‘bear market bounces’ seen during this now nine-month selloff,” he wrote last week.
On Monday, JPMorgan’s Marko Kolanovic weighed in. “Risk markets appear to have largely ignored weak economic data and if anything, equity markets rebounded,” he wrote, along with colleagues including Nikolaos Panigirtzoglou and Bram Kaplan.
If you ask JPMorgan, the “insensitivity of risk markets to weak economic data is the result of two main factors,” one of which is the above-mentioned low positioning from equity investors. The other factor is the possibility that a lot, if not all, of the cyclical weakness is already in the price.
Do note: Not every iteration of “it’s priced in” is a nebulous cliché. I met my sarcasm quota for Monday, so I’m free to remind readers that markets actually are some semblance of efficient. Stocks do tend to pull forward expected future outcomes.
“This goes back to the belief that markets and the economy are not synonymous, as equities, rates and credit have all captured a large part of the anticipated turn in the business cycle, well ahead of the actual ‘realization,'” McElligott said.
The figures (below, from JPMorgan) show cyclicals underperforming in 2022 and downward earnings revisions materializing.
“So far this year, earnings revisions have advanced to a very large extent, tracking the pattern seen in previous recessions, thus already incorporating significant earnings declines going forward,” Kolanovic and colleagues wrote.
I should emphasize that this discussion is 30,000-foot. This week is obviously critical for earnings. If the FAAMG cohort doesn’t deliver, or merely fails to give the all-clear, any associated weakness in the shares could pull the broader market lower precisely because they are the “broad” market. So, none of the above should be in any way construed as a tactical comment on tech earnings.
Rather, the point is that something’s in the price. Because the price is lower than it was in early January. What, exactly, it is that’s priced in is the subject of vociferous debate. De-rating was a function of rising rates, and while there’s considerable disagreement about the trajectory of corporate profits going forward, we can all agree that bonds have at least begun to price in recession risk.
“In all, while recession odds are increasing given weaker economic data, we believe that at least a mild recession is already in the price,” JPMorgan said Monday, summarizing. The bank is “cautiously optimistic” and has a “sizable equity overweight” in its model portfolio, hedged with an underweight in credit. They’re also “more positive” on duration given the relatively higher odds of a downturn.
The market certainly does not appear to have discounted Walmart’s forecasts.
Not to be a quibbler …. but the equity market often does not appear to discount many obvious things. People coming from the fixed income, commod & FX markets often marvel at how equities need to be hit on the head with data before reacting. Perhaps that was a carryover from the days when fun managers would take days, weeks or months to react to economic factors? Today it’s push a button to sell all or push a couple to rotate from one sector to another.
Earlier today, I lampooned inefficient equities. Later (i.e., here) I tried a less sarcastic take. It clearly doesn’t work. Everyone wants doom, gloom and sarcasm all day, every day.
Also, rates are the furthest thing from “efficient.” Unless of course you think Italy, Portugal and Spain were better credits than the US for a prolonged period, because thanks to the ECB, that’s what “efficient” fixed income said.
Another thing “efficient” € fixed income said in August of 2019 was that 100 (that’s one hundred) corporates were able to borrow at negative rates. And no, there are no mistakes there. Late in Q3 2019, 100 corporate borrowers in € fixed income enjoyed negative yields across every maturity. For those corporate borrowers, debt was an asset. Plug that into your models and see what comes out. Howard Marks tried, and it didn’t compute.
As for FX, the yen should be the bolivar. It’s issued by a government that’s perpetuated a circular funding scheme so large that there are days when the sovereign debt market barely trades. Also, it’s an island nation that’s constitutionally forbidden from having an army and could be swallowed up by one large tidal wave. Those are just barely exaggerations. A “safe haven” it is not.
So, please, spare me the “fixed income and FX are smarter” line. They’re not. All of it — every, single bit of it — is just a manifestation of central banks, irrational carbon-based traders and hair trigger algos. It’s all meaningless. Just lines on screens.
And people love to talk about those lines going lower when the lines represent stocks, because fear sells, but people don’t actually want the lines to go lower, because those lines represent the value of their retirement funds.
There’s some Monday afternoon snark for you.
WMT’s guidedowns imply 2022 EBIT -12% YOY, EBIT margin -90bp YOY to 4.1%, turning the margin clock back to 2019’s 4.1%.
TGT’s guidedowns imply 2022 EBIT -37% YOY, EBIT margin -330bp YOY to 5.7%, turning the margin clock back past 2019’s 6.0%, to 2017’s 5.2%.
In 2008, WMT’s EBIT did not decline (+3.7%) and EBIT margin merely -20bp. TGT did see EBIT decline (-16%) and EBIT margin rolled all the way back to 2002.
Looking at EBIT, then, these two retailers are already being hit harder than in the 2008 Recession.
Yet the consumer has only been pulling back for four or five months, and there is some debate as to how much retrenchment has yet spread from lower income upwards.
As we’ve discussed many a time here at Dr. H’s Most Excellent Water Cooler, with high wage-and-everything inflation, pandemic over-earning, and supply chain woes past-and-continuing, one doesn’t need a large recession, or maybe a recession at all, to produce a large Profits Recession.
So far, it looks like a mere “maybe-a-technicality-recession” is doing it, for these companies.
Here’s some Walmart: https://heisenbergreport.com/2022/07/25/everyday-low-guidance-walmart-delivers-another-reality-check/
Yeah, these aren’t goofy little mall brands with second class managements that routinely blow up, WMT is not Charming Shoppe and TGT is not Torrid. If (rhetorical “if”) they got this wrong then other major retailers did too. Reading 1Q calls from various retailers, I see all kinds of managements saying that Americans’ newfound passion for healthy living, authenticity, experiential lifestyle, etc is going to be sustained which is why their highwater 2021 sales/store will recede only a little bit in 2022. Most of those are not selling the genuinely non-discretionary stuff (food, etc) that is allowing WMT to miss less egregiously than retailers more focused on discretionary, like TGT and many others.
Consensus forecasts for some of those whistling-in-graveyard retailers makes them look very attractively valued. I’d want to see each blow up the customary three times and approach 2020 lows, before doing any bottom fishing.
JP Morgan is now “more positive” on duration.
Well that’s good to know.
A bank, which lives and breathes interest rates every day, has a slight intuition that long bonds should be bought.
If demand for mortgages is waning, then long-term interest rates must drop. Right? So what’s the question? Are long bonds going up or not?