For those of you who would prefer to listen:
Let’s start with this: It was the best January for the Stock Market since Covid. Taking it a step further, the Tech-heavy NASDAQ had its best start to the year since 2001. Then there’s this: February has started off even stronger than January. There’s still a tough road ahead in 2023, but it sure is nice seeing all this green on the screen again, don’t you think?
This was a busy week for Wall Street. There were many Market-moving events. We are knee-deep in Earnings Season. This was the busiest week. There was a slug of economic data reported, capped off with the January Job Report. But the biggest event that moved the Market was undoubtedly the Fed meeting. I’ll start there.
The Federal Reserve slowed its pace of rate hikes to a 1/4-point this week. That was down from the 1/2-point increase in December, which followed four back-to-back 3/4-point hikes. The Fed has been on the most aggressive interest rate hike campaign in four decades with the intent to tame inflation. You knew that already; That’s what brought the pain to 2022.
The widely expected quarter-point hike followed the recent economic data suggesting inflation peaked last year and kept decelerating over the past few months. This has provided confidence to the central bank that the rate hikes have been working. The Fed still plans to increase rates again in March. But the rate and pace seem to be slowing. America’s central bank has doubled, tripled and even quadrupled down on its higher-for-longer interest rate mission. Based on this message, it seemed clear the Fed won’t be satisfied until recession sets in. But the press conference saw a much more Dovish Fed Chair Powell. He was composed with a sense of satisfaction that the work the central bank has done has worked. Powell gave plenty of signals that the tightening squeeze is coming to a close. The Stock Market loved that. It triggered a risk-on rally, which has already been the case in this young year.
For the first time in a long while, the more Powell spoke, the higher stocks spiked. That is incredibly new. I’m not sure this was his intent and the likelihood that he’s surprised and a little miffed about the Market response has to be high. The Fed Chair intentionally talked down the Market at his Jackson Hole speech last August, after a pretty powerful rally. The set-up is here again with some of the most speculative securities shooting higher and leading the charge. That goes completely against the grain of the Federal Reserve’s intent. Is it a coincidence that the S&P is back to those August levels?
Fed officials expect the terminal rate to exceed 5%, with none indicating a willingness to cut for the rest of the year. The Market thinks the Fed not only stops the rate hikes by Summer; It expects actual rate cuts by year’s end. But the Stock and the Bond Market are telling different stories. The Stock Market seems to be focused on a soft-landing, with the worst behind us. The Bond Market has been pricing in a harder-landing with a recession ahead. There’s definitely a disconnect. History has shown, ultimately, it’s the Bond Market that’s usually right.
Inflationary pressures have not abated completely and there are some areas where it’s picked up again. Gas prices jumped 12% in January, threatening the Fed’s inflation fight. Winter storms in December contributed to tighter supply. And January’s mild weather across the country has led to more drivers on the road pushing up pump prices. Gasoline exports have also doubled from a year ago as China’s re-opening means a significant increase in fuel consumption. This, on top of Europe’s ban on Russian Oil starts next week. So, there’s that.
This was the busiest week of the Q4 2022 earnings season. Roughly 20% of the S&P 500 companies accounting for 1/3 of total Market value reported earnings this week. The Tech Titans were atop the list and were expected to deliver weaker earnings growth than the rest of the group. But there was a real question if the already low expectations were priced in. The latest Bank of America Global Fund Manager Survey showed positioning in Tech was 2 standard deviations below average. After a terrible 2022, Tech was grossly under-owned.
JP Morgan’s Market Intelligence report pointed out that funds have been adding to Large Cap Tech stocks like Alphabet, Apple, Meta and Amazon in January. That makes sense since most of them are up significantly in the young year. So far the Q4 earnings reports continue to underwhelm with less than 70% of reporters beating Street estimates. Those that have beat are doing it by a meager 2%. So far we are through 250 of the S&P 500 companies and revenues are on track for +5.1% growth while earnings are showing a decline of 3.77% year-over-year. Expectations got pretty low. Growth is no longer the theme as you can see in this quarter so far, earnings are decelerating for the first time since Covid. Cost-cutting and survival is. The Street still expects a burst of growth in the second half of 2023. It’s far from clear if that happens.
Here’s a rundown on some of the Market-moving earnings reports with important takeaways:
Meta, also known as the company formerly called Facebook, reported an eye-catching quarter. After a dismal 2022, the social media/augmented reality company continues to heal by reining in its wild spending spree. Revenues beat expectations. But what really made an impact was the significant cost-cutting measures as well as a massive stock buyback program. Meta also forecast Fiscal Q1 revenue that could reach as high as $28.5 Billion, which would top sales seen during Q1 of 2021. That was its record year for revenue. CEO Mark Zuckerberg called 2023 the “year of efficiency,” with the company “focused on becoming a stronger and more nimble organization. They mentioned cost efficiency 28 times on the conference call. The Street liked it. The stock soared 20+% on the news. That triggered a rally in Tech. It was something to see. Keep in mind, it declined over 60% last year.
Amazon reported a mixed quarter, with a solid beat on revenue but a miss on earnings. Its growth engine cloud business, known simply as AWS, grew just 20%. That is the slowest growth rate since the company started reporting it as a standalone business. It’s coming off record comparisons in 2021. Amazon’s retail division grew just 2% year-over-year, though it did have its best Thanksgiving weekend in history. Amazon is a good barometer for spending, both at the corporate level and retail. Both segments are slowing their spend.
Amazon has been cutting costs after an extended period of aggressive spending to catch up with surging demand during the pandemic. It doubled its employee base to nearly 1.5 Million people. It has already started laying some off. More is expected to come. The company also raised the price minimum for free grocery delivery from Amazon Fresh from $35 to $150. The Market likes this new cost-conscious approach. Amazon is up over 30% this year. The stock was cut in half in 2022. The re-set is in.
Google, formally known as Alphabet, reported a double-miss. The company came up short on both sales and profits. This was just the second time ad sales fell since Google became a publicly traded company in 2004. The other time was when Covid first broke out. With such a dominant position in search for years, Google hasn’t been accustomed to increased competition. It is now. Competition has gotten fierce in Google’s expanding sphere. The onset of ChatGPT is attracting an increasing number of searchers away from Google like a magnet. Its YouTube division saw a revenue decline for the second consecutive quarter as it competes for eyeballs with TikTok.
Google is going all-in on its Artificial Intelligence campaign with the expansion of its DeepMind division, designed to compete head-to-head with OpenAI. They own ChatGPT. Microsoft is a large investor in OpenAI. It’s a powerful threat. Google has called itself an “AI-first company” for years. It’s one of the great innovators in Silicon Valley. But success can breed complacency. Management is feeling the heat and sensing the urgency to regain the innovative lead. So much so, Google brought back co-founders Sergey Brin and Larry Page to spearhead the movement. Google plans to cut spending in excessive areas to account for the economic slowdown while maintaining an aggressive investment mode in innovation. The Market seems to like this new balance. The thing is, cost-cutting is not in Google’s DNA. The search for growth is a constant. But the days of frivolous spending are over, at least for this cycle.
Apple reported a double-miss too, a rarity for this company. Apple came up short in Street expectations for the iPhone, iPad, Macs and watches. China was a big reason for this. Supply chains are still recovering, and the Chinese Economy is just beginning to re-open. Apple CEO Tim Cook said the supplies of the iPhone 14 Pro and iPhone 14 Max were significantly reduced last Fall. There were fewer phones to sell to customers. He implied it had nothing to do with demand. The primary iPhone assembly plant was affected by China’s Covid lockdowns. Apple had already warned of this back in November.
The big question ahead is whether Apple will see another large replacement cycle for iPhones later in the year. Wallets are tightening. People are holding onto phones longer than usual. Apple also needs to keep expanding its product line beyond the phone. iPhones still account for over half of Apple’s revenue. Its services business keeps growing, which is more profitable and stickier. That’s something the Market definitely likes. Overall, it was a fairly uneventful quarter for the most valuable company in America. The stock is up 18% in the new year, indicative the Market is taking the double-miss very much in stride.
McDonald’s provides an insightful look into consumption trends. The Golden Arches reported its same-store sales increased over 12% year-over-year. That beat Street expectations. The company had strong revenues and took market share across regions. Prices in the quarter increased 10%, accounting for the majority of the revenue increase. Profits were squeezed a bit due to the higher input costs. Did you know that McDonald’s rolled out Adult Happy Meals? Apparently they were a success, being a key driver for revenue growth in the quarter.
McDonald’s made investments in digital systems, like mobile order, which will make the company more efficient per square foot. McDonald’s is also testing out to-go only restaurants with no seating and minimal humans, using conveyor belts to deliver advanced ordered food. Americans are out and about and companies continue to try to provide the goods and services to meet the changing demand structures.
While many companies are hunkering down and cutting costs, McDonald’s plans to open 1,900 new restaurants around the globe. Over half will be in China. The company re-opened some of its restaurants in Ukraine, marking a symbol of support and success. 60% of McDonald’s revenue comes from outside the United States. McDonald’s raised prices in 2022 to help cover the cost of inflation. It didn’t deter its customers. In fact, McDonald’s saw a 5% increase in its customer base from a year ago. Not everyone has pricing power. The Big Mac house does.
UPS is a bellwether for economic activity. The company slogan for years was “Moving at the Speed of Business.” UPS made it clear that business is slowing. The company missed revenue expectations but beat on earnings. UPS also lowered its outlook for 2023.
Revenue for UPS’ domestic segment, which accounts for approximately 2/3 of the company’s total revenue, grew 3%. Revenue from international shipping shrunk by 8%. UPS cited lower overall volume and softening demand in China. Its supply chain business saw revenue slide 18% with volume decreasing in its freight forwarding business. That was partially offset by its healthcare segment. Both UPS and its largest competitor Fed Ex raised shipping rates by 6.9% at the end of last year. That was designed to help cover their increased overhead costs, primarily fuel and labor. Those are costs that many companies continue to grapple with at a time when commercial activity slows.
Exxon recorded a record quarter. The largest American Energy company reported an all-time high for earnings and revenue on the back of higher Oil prices. What a difference 3 years makes. In 2020, Exxon reported its first profit loss in 4 decades after the price of Oil broke the buck. Covid crushed energy demand. Covid crushed energy companies. Few showed sympathy then. Many are angry now. Big Oil has long been an easy target for politicians. But Exxon invested aggressively in American production when other companies struggled. US production is still below pre-Covid levels, which has contributed to higher Oil prices, increasing inflation.
Realistically, US Energy companies are the good guys in a really dirty business. They’re competing with adversarial forces. Russia, Iran and Saudi Arabia do not care one iota about the American people nor the environment. Renewables are essential for our future. Exxon plans to ramp-up spending on clean-energy investments by focusing on carbon capture, hydrogen and biofuels. The company cited the Biden Administration’s Inflation Reduction Act as a key policy pillar that improves profitability of decarbonizing existing operations. That holds promise in investing for the future. But one thing has been made clear in this environment; The World still runs on crude.
517K jobs were created in January. That was more than 3X the expectations. December was revised higher too. The unemployment rate slipped to 3.4%, undercutting that 50-year low. This doesn’t square with a normal economic slowdown. The American Economy has never been in recession with historically low unemployment. It’s been the lone perplexer for the Fed as it has combatted the sky-high inflation. On the one hand, the job environment supports the soft-landing scenario. Anyone who wants a job can get one. Having an income supports spending, which drives economic activity. On the other hand, increased spending is inherently inflationary. It makes one question how they’re measuring labor and economic output. This could keep the Fed hiking interest rates, or at a minimum keeping rates higher for longer, just as Fed Chair Powell outlined. Rate cuts seem unlikely, without recession ahead.
Additional optimism was seen in Washington this week. House Speaker Kevin McCarthy said he had a “very good discussion” with President Biden about government spending and the debt ceiling. Both sides say a deal can be had and that a default on American debt won’t happen. Those are encouraging words. But we know all too well that the makeup in Washington is complicated with a large dose of dysfunction. This issue seems inevitable to bring some stress to the system as we head towards Summer. That’s an overhang.
Back to the Market:
The strong rally to start the year caught many investors offsides. Stocks were hated in December. Negativity was so rampant as 2022 closed, a mean reversion from grossly oversold levels looked likely to start the year. As we outlined in our 2023 Outlook piece a month ago: “A rally to start the year would catch most by surprise. We could see that play out: The Economy keeps slowing, the Bond Market tells us inflation is less of an issue and the Fed will ultimately end its choking rate-hike campaign. That would provide more breathing room for stocks for another Bear rally before ultimately bottoming out. That’s our base case right now. We’re staying nimble. One thing seems certain: The volatility will continue in 2023. We are prepared and positioned accordingly.”
We sure didn’t expect things to start this strong. That said, a positive January bodes well for the rest of the year. Since 1950, a positive January has resulted in a positive year over 80% of the time. What is abundantly clear is, the stuff that got beat up the most in 2022 is what’s leading this new year lift. The most speculative, junkiest stocks have done the best in this rally. Case in point: Bed Bath & Beyond. The company that warned bankruptcy might be inevitable, missed a debt payment for the first time this week. Despite its existential crisis, Bed Bath’s stock has soared 33% this year. It’s nonsensical. If bankrupt, the stock will go to zero. This speaks to the speculative fever that’s returned. Add this stat to the speculative fodder: yesterday was the largest US equity options volume day, EVER. 40 Million Calls (Bullish bets) traded and the most active were options expiring in just 1 day. That’s ultimate speculation. On the flipside, the highest quality stocks, which held in so well in 2022, have been for sale this year as investors chase growth. We aren’t chasing. We still like those quality names.
There’s nothing like a Bear Market rally to suck people back in. This seasonal influence has brewed a new confidence for the Stock Market following the brutal 2022. Investor sentiment reflects this shift. According to Investors Intelligence, the number of Bulls pushed up to 47.1% this week. It’s important to note, that is the highest Bull reading since the last week of 2021. That marked a significant top. As I’ve said many a time, there’s nothing like price to change sentiment.
Have a nice weekend. We’ll be back, dark and early on Monday.