Get me out of the house
A quiet start to the week descended into chaos Wednesday morning as markets reversed sharply following woeful earnings from Netflix. The selloff accelerated after hawkish comments from Fed Chief Jerome Powell indicated that a 50-point hike of the Fed Funds Rate was a foregone conclusion at the FOMC’s upcoming May 4-5 meeting.
The S&P 500 finished off 2.75% last week, notching its third straight weekly drop, while the Nasdaq Composite fared even worse, shedding 3.83%. The 10-year treasury ticked higher, closing at 2.93%, though moves were more pronounced at the front-end of the curve, with the two-year ending Friday’s session at 2.71%.
The pain within equities was broad and far-reaching, with only a few pockets evading the flight from risk assets. Year-to-date winners, from commodities and energy to health care, all imploded in spectacular fashion. Weakness continued for the year’s biggest losers, notably stock with still stratospheric multiples (ahem….growth tech) and work-from-home beneficiaries.
The market is now pricing in a Fed trajectory that would feature a 50 bps hike in early May, followed by 75 bps in June and another 50 bps in July, bringing the Fed Funds rate to 2.00%-2.25% before we’re halfway through with Summer. While that pace is slightly more aggressive than markets anticipated prior to last week, it’s still accommodative and negative in real terms after accounting for inflation.
Instead of harping on all of the pockets of carnage amidst last week’s meltdown, let's celebrate a few themes where investors found some relief.
Will we finally get a Gatsby Summer?
One area where increased prices hasn’t deterred consumer demand is summer travel.
Last year a fresh wave of Covid robbed many of the long-awaited and much anticipated opportunity to let loose. From weddings, to overseas vacations, to finally getting kids back to camp, the coming months will tell just how much Americans are willing to spend to relax and make up for lost vacation time.
If airlines are any indication, higher prices aren’t holding people back.
Delta kicked off earnings season for the group on April 13 with a huge revenue beat and positive guidance, with CEO Ed Bastian saying he expects the carrier to fly at 84% of 2019 pre-Covid capacity in 2022.
That momentum continued last week with United and American Airlines’ releases, the stocks surged 14% and 6.7% respectively.
All three airlines saw quarterly losses but expect to return to profitability in the second quarter, led by a return of leisure travel and a comeback for corporate fares, even while much of Asia remains closed.
American Airlines forecast Q2 revenues to be 8% higher than their 2019 levels, despite running six to eight percent less flights. This goes to show how much more operationally efficient these airlines have become in the last few years.
Against the strong performance for the three largest American carriers, investors in the U.S. Global Jets ETF (JETS) may have been disappointed to see their fund underperform, only managing a 2.7% weekly gain.
Know what you own with Noonum:
In looking at JETS – United, American, and Delta feature as the three top holdings, comprising just over 35% of the fund.
But this ETF also has exposure to a number of domestic carriers, such as Southwest and Spirit, that don’t stand to benefit from the rebound in business travel or premium fare classes. The ETF has a far lower concentration to themes like “business travel” and “premium fare” than the three largest domestic carriers.
With JETS, you’re not just getting pure play exposure to the airlines, either.
5.5% of the fund is spread across Expedia (EXPE, -5.17% last week), Tripadvisor (TRIP, -4.1%), and Booking Holding (BKNG, -0.60%).
Noonum shows that these stocks bring added exposure to different components of the travel industry (hotels, cruises, digital advertising), as well as eCommerce and software. These were amongst the hardest hit areas of tech last week and were a major contributor to the underperformance of JETS relative to the three leaders.
With JETS, an investor is also exposed to international airlines and manufacturers like Boeing (BA), which is off over 12% this year versus a 12% YTD gain for American.
For investors it comes down to understanding what you own. Noonum helps explain all of the thematic drivers that pull a fund in different directions.
Back from the Dead? The Resurrection of Legacy Enterprise Tech
Five years ago if you had to throw your money behind one large-cap tech company there’s a good chance IBM wouldn’t have been at the top of your list. The 5-year returns of the 111-year old company versus other mega-cap tech stocks would justify that:
Alphabet (GOOGL): +158.8%
Amazon (AMZN): +212.1%
Microsoft (MSFT): +300.3%
And at the other end of the spectrum:
Frustrated IBM bag holders would be vindicated in their disappointment, the stock’s underperformance followed 22 straight quarters of declining revenues from 2012 to 2017.
The company, however, may have finally turned a corner. After posting 6.5% revenue growth in Q4 2021, the software maker’s rebound gained steam in Q1 as the company increased revenues by 8%. That strength was driven by its cloud and consulting services businesses, showing that the company’s 2019 acquisition of Red Hat for $34B is starting to pay off.
Several factors drove the stock’s +9.2% gain last week.
Aside from the surprising revenue print, IBM is meaningfully under-owned by institutional holders relative to other mega cap tech stocks. It also pays a 4.75% dividend, a rarity in the world of tech, and has become a hallmark of the newfound appetite for “growth at a reasonable price”.
Using Noonum’s graph to understand others that might benefit:
Beyond giving you the ability to understand the themes that are driving markets, Noonum’s knowledge graph helps provide context for all of a company’s relationships – from trading partners, to competitors, to potential acquisition targets.
Looking at names that share exposure to similar themes and have correlated price movements, Noonum can also show other companies that will be affected when a given stock experiences unusual activity.
Four of the top stocks that Noonum’s graph flagged as companies that would be influenced by the IBM announcement showed strength during last week’s selloff:
Hewlett Packard Enterprise (HPE): +2.4%
Juniper Networks (JNPR): +0.1%
Dell (DELL): -0.2%
U.S. video game makers:
- Electronic Arts (EA, +3.5%) and Take Two Interactive (TTWO, +3.7%) both bucked the trend on Friday after Bernstein upgraded the pair, calling them the “adults” in the video game room
- Meanwhile, the Roundhill Esports & Digital Entertainment ETF (NERD, -0.7%) slumped given international exposure following Chinese government crackdown on unauthorized livestreams
- Use Noonum to understand this fund and what’s weighing on performance (there's some head scratching exposure within)
Bored Ape NFTs:
A surprising standout amongst speculative assets has been NFTs, notably the Bored Ape Yacht Club, a collection of 10,000 JPEGs where market sentiment is often gauged based off of recent sales or the price floor – the lowest price that an existing owner would part ways with a holding.
The price floor for Bored Ape NFTs fell from a mid-Feb high of ~$320,000 to ~$173,000 in early March, following the broader selloff in the S&P 500.
Interestingly, Bored Apes have held in during the most recent dip in equity markets as the price floor hovers near an all-time high, currently hovering around ~$395,000. Other NFT projects haven’t fared nearly as well.
The Fed, for lack of a better word, finds itself in a pickle.
It needs to temper inflation.
Powell knows that one way to cool prices is to rein in demand. The best way to bring down demand is to make people feel less wealthy.
How do you make people feel less wealthy?
Hit the value of their portfolios.
So we find ourselves in an environment where the Fed not only wants the market to come down, it needs it lower.
But it doesn’t want the market to come down so dramatically, or so broadly, that it goes beyond removing excess and taming runaway inflation, and induces a recession or threatens the labor market.
In 2018 the Fed commenced a tightening cycle that pushed the market to the brink of bear market territory, with the S&P 500 falling 19.78% from its Sept 20th high to its Dec 24th low.
In that instance, the rapid selloff forced Powell to shift gears, as he pivoted in early 2019 and advocated for monetary policy patience, establishing a floor under equity markets.
The key difference between the 2019 and 2022 Fed is that in the first episode, Powell had the luxury of restraint. His primary motivation was rebuilding the central bank’s policy war chest. The 2022 Fed has a more pressing task – fending off rampant inflation.
Resolving supply chain backlogs will help, but two of the largest contributors to the +8.5% YoY March CPI reading were food and energy. Those forces owe more to sanctions and the war in Ukraine than anything the Fed has control over, meaning inflationary headwinds could persist for some time.
We find ourselves in a scenario where the Fed wants to force some level of correction so that investors feel less flush. The S&P 500 closed on Friday at 4,271, roughly 3% off its March 8 low.
At what level do spending habits start to change – 4,000? Would that be enough for Powell and other Fed governors to dial back the tough talk?
2022 has all the makings of a sideways, range-bound market. An S&P 500 at 4,000 would reflect a 17% drop from its Jan 4th all-time high. If that’s enough for the Fed to take its foot off the pedal, stocks would certainly rally, but perhaps only back to a point where Powell & co. feel comfortable resuming the hawkish march.
We could be playing this game for some time.
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Disclaimer: all opinions expressed are the author’s own and nothing contained in this column is intended as financial advice