Happy Sunday, Traderade family! I hope everyone has had a wonderful holiday break. We have an exciting week ahead of us, especially with the volume of key economic data we have coming out. Let's dive in!
Last week we saw a a holiday-shortened week levitation in equities, with most of the S&P 500 participating to the upside, with some noteworthy exceptions, like AAPL, AMZN, META, GOOGL, and TSLA. The only US big techs that performed well were MSFT and NVDA.
We saw noteworthy strength in utilities, which were up 5.27%. Consumer staples were up 3.19%. Low volatility large caps also outperformed their high beta peers by 1.01% during the week that was.
All of this points to a relatively risk-off rotation underneath the surface. That is to say, despite there being widespread positive breadth, the best performing sectors were defensive and the majority of the gains were in low volatility stocks.
We had a wild week in commodities. Coffee was caffeinated enough to move up 7.27%, natural gas had fiery demand, sending it climbing 6.7%. On the other side, WTIC oil slid 4.06%, with wheat profit harvesting leading to a 3.7% decline.
Rates dropped across Treasuries of varying duration, particularly on the longer end, where we saw the 30-year bond yield fall to 3.751% and the 10-year note yield to 3.689%.
The yield curve continues to give economists nightmares as it portends to a rather unforgiving recession coming as it is the most inverted it has been since 1981 at -74 bps (or 0.74%).
High yield spreads remain contained at 451 bps, with junk refusing to register any meaningful concern about economic conditions seeming set to worsen in the new year. Part of this phenomenon may be the thirst for yield, but I imagine that this debt is likely going to see higher yields in 2023 vs investment grade as we begin to see increasing stress from lower quality corporate borrowers.
I know that nobody reading this could possibly be tiring of the never ending parade of Fed speakers who grace us with their jawboning week-after-week. So, good news! We have another week of the same! Even our good friend Chair Powell will be speaking on Wednesday at 1:30 pm ET.
The good news is that the Fed's blackout period begins at the end of this week. Thank goodness for small miracles!
Remember that like other areas of life, it is always important to focus on the signal and tune out noise. Economic data is often a lot like that as well, which is why I tend to focus much more on key data releases, and while I will look at all of the data that is shared, I put the most attention into the data that tends to move the markets.
For that reason I'm not focused on Monday, but the rest of the week has key events worth watching every day.
We have a lot of housing data coming out this week, starting with the S&P/Case-Shiller Home Price Index. The last reading from August showed a 13.1% year-on-year increase, that was the fourth month of slowing home price growth, with 20 major cities reporting slower price increases.
The forecast for September's data is a year-on-year gain of 10.5%, which would mark another consecutive month of home prices slowing down from last year to this one. We see that deceleration also manifesting itself in month-on-month pricing declining 0.6% and 0.7% over the last two releases, with the forecast for this September month-on-month being a larger decline of 1.2%.
Suffice it to say, we can see home prices are not only slowing in their increase year-on-year, but are actually beginning to fall month-on-month. An encouraging sign to be sure, as the real estate market had become quite overheated as a result of aggressive Federal Reserve easing, particularly in the mortgage-backed securities market, causing distortions in rates that benefited the US real estate industry in the short-term, but likely created a hangover from all of that demand being pulled forward.
The most important data I'll be watching on Wednesday is the preliminary GDP release. The expectation is for a 2.8% quarter-over-quarter gain in Q3 2022, revised up from 2.6% during the initial advanced release.
I'll be watching where data was revised during this release. I continue to wonder whether this apparent recovery in GDP is going to turn out to be a false dawn before what is likely to be a much slower economy in 2023.
We also have JOLTS on Wednesday, which gives us a sense of how tight the labor market may be. It's a key area of data as the Fed wants to see greater weakness in the labor market as a part of their campaign to reduce inflation from the demand side.
Last month's release wasn't very encouraging, and if we continue to see more new jobs offered that may suggest that the Fed has even more work to do in order to add some slack to the labor market such that we see the economy begin to slow down more meaningfully.
Chair Powell's speech at 1:30 pm ET will be key to monitor as we may see some hints of what we can expect in December, which is likely to be a 50 bps hike and more talk of "higher for longer", albeit at a slower pace.
The most important data sets on Thursday are going to be PCE and ISM manufacturing PMI. The last year-on-year US Core PCE reading was 5.15%, and that continues to suggest an uncomfortably high level of sticky inflationary pressure, as the metric nets out food and energy which tend to be more volatile.
If we see these PCE readings come in cooler than expected it's likely we see a nice rally off of that. The opposite is likely to be true if they are hot, we may see the market weaken meaningfully. I like to watch the bond market after the data is released, particularly the 10s and 30s. Rising rates typically put more intense pressure on equities, particularly longer duration risk, like tech and growth.
The Fed wants to see inflation come down to 2% as measured by year-on year PCE, which last registered 6.2% during September. That means there's still a whole lot of work to do for the central bank. Chair Powell acknowledged that during the last FOMC press conference, and the recently released minutes suggest as much as well, despite the slowing in individual hikes that is planned.
US ISM Manufacturing has been approaching contraction territory, and the next reading is expected to confirm that at 49.8, where any reading below 50 is a contraction.
Because ISM is a leading indicator, this is yet another sign that we are likely facing a more difficult economy in the year ahead. The worse the reading in, the more the market may like it as we're in a "bad news is good news" environment with the Fed targeting economic weakness as a part of their policy framework to subdue the velocity of inflation.
Unemployment claims will also be important to watch as the market continues to look for signs of softening in the labor market. If we have weaker than expected data (more losses) it will likely be well received.
Lots of key jobs data comes in on Friday, including Average Hourly Earnings, Non-Farm Employment Change, and the Unemployment Rate. Non-farm Payrolls are showing some signs of slowing after a powerful post-COVID crash recovery.
Further slowing would be welcome by the market, which expects just 200K jobs created in November vs 261K in October.
The Treasury auction schedule is pretty sleepy, with just three bill auctions, and no notes, bonds, or TIPS.
I don't tend to pay too much attention to these bill auctions as they are often quite well subscribed as there's no lack of demand for short-dated Treasury paper. If that should change, however, it would be a pretty big red flag. For now smooth sailing is expected at the bill auctions.
Earnings highlights to look for next week from Bloomberg:
Monday: Pinduoduo (PDD US) reports before the opening bell. The Chinese e-commerce firm, famous for its group-buying discounts, is projected to post top-line expansion of 43.7%, slightly above the double-digit growth momentum seen in the last report, according to Bloomberg consensus.
Revenue gains could have surpassed additional marketing expenditure, Bloomberg Intelligence said, as the Shanghai-based company attracted more mainland Chinese shoppers with its expanded grocery offerings during the country’s continued Covid lockdowns. Meanwhile, Citi analysts expect Pinduoduo to benefit from consumption trade-down and even see a potential beat in profit, in spite of overall macro weakness and seasonal slowness during the quarter.
Tuesday: Bilibili (BILI US) is due premarket. The popular Chinese live-streaming and broadcasting platform, which has yet to turn a profit, is poised to see its losses narrow due to cost controls in research and a potential rebound in advertising growth driven by looser pandemic mobility curbs in the third-quarter reporting period, according to Bloomberg Intelligence.
However, sales growth likely remained muted, BI also said, due to soft consumer spending in the country - a macro weakness that Bilibili and its Internet peers have experienced over the past two years. Bilibili’s shares have been sensitive to recent China news including the Biden-Xi meeting and a fresh Covid outbreak, and took a beating after its removal from Hong Kong’s Hang Seng China Enterprises Index and Citi’s rating downgrade. These factors have all contributed to the company’s about 72% year-to-date decline, compared to an about 36% fall in the NASDAQ Golden Dragon China Index.
Wednesday: Salesforce (CRM US) is due after the close. The third-quarter report, which comes on the heels of layoffs and a stake taken by activist investor Starboard, will test the company’s earnings resilience within a sector overshadowed by a strong US dollar and tightened customer software budgets.
Revenue is projected to grow at the slowest pace in at least 17 years, while gains excluding currency impact could be at the lowest level in at least 12 years. Citi also pointed out that guidance for current remaining performance obligations, an indicator of near-term demand, may be “underwhelming” with limited room for a positive surprise. Investors tuning into the earnings call will expect an outlook for the next year, said Guggenheim analysts, who are seeing “significant risk” in the company’s ability to meet Wall Street consensus for fiscal 2024.
ESG in Focus: PVH (PVH US), also due postmarket, aims to have three of its most commonly purchased apparel products be “completely circular” - including the traceability of key raw materials - by 2025. The market may be interested in an update on that goal, as it is the sole item labeled as “under revision” in the company’s progress report.
The revision status is thanks to PVH’s partnership with the Ellen MacArthur Foundation to “adjust [its] strategy for greater impact,” per the company’s 2021 corporate responsibility report. The introduction of extended producer responsibility, a key concept in proposals by the European Commission and the state of New York, could raise costs or require adjustments to business models, Bloomberg Intelligence Senior ESG Analyst Gail Glazerman said. This goal has also been set despite the fact that large-scale recycling of used textiles into new clothing does not yet exist.
Thursday: Kroger (KR US) is due before the open. Consensus estimates suggest a sixth consecutive quarter of revenue growth from its core grocery business, thanks to strong food-at-home demand, according to Bloomberg Intelligence.
However, gross margin is likely to remain under pressure through the second half due to higher product, labor and transportation costs. Its pending merger with Albertsons has been in focus recently due to legal challenges surrounding Albertsons’ intent to pay a $4 billion special dividend.
A note from our own Ayesha Tariq, CFA on ULTA:
Ulta (ULTA US) has habit of beating estimates. They've done that for the last 7 quarters in a row. Estimates for this quarter are lower than what they achieved last quarter. EPS is estimated at $4.12 and revenue at $2.2B. The company is set up for yet another beat. Ulta's inventory situation has been manageable.
They've consistently been increasing margins as well. But, let's not forget what Estee Lauder and Olaplex told us earlier in the quarter. People are cutting back on discretionary beauty spending. We also heard from P&G who told us that people are foregoing their expensive brands like SK-II and opting for more regular priced ones.
Ulta is also relying heavily on their partnership with Target (TGT US) and we all know how Target reported. Discretionary is not doing well and in the next few quarters we need to watch this company for bargains and lower margins.
Friday: No major earnings scheduled.
I expect that we'll have no shortage of market turbulence in the week ahead. Markets are starting to look a little bit frothy in terms of where valuations are and what earnings and the economy are likely to look like next year, but the temporary suspension of disbelief is the key to any good fictitious narrative, and for now the narrative is that a Fed slowdown is somehow tantamount to a pivot.
While that's hardly the case, it's been enough for the market to get rather excited about every hint that points in that direction, despite the view for a smaller hike in December being the baseline for most of the second half of 2022. While we aren't overbought or nearing anything resembling buyer exhaustion, we're also in a very poorly hedged and illiquid environment. Tails are fat in both directions, but particularly the left.
Be nimble.