This was another one of those weeks of studying facts and developments, which there are many, in order to gauge and anticipate the path ahead. There’s clearly a lot going on. I participated in a number of strategy sessions with a broad focus on Geopolitics, the Economy, the Fed, inflation, earnings and the upcoming election. That’s effectively the Market and it’s been moving fast. Here’s a rundown of events and where we think things are headed.
The Market remains largely focused on the Fed, and its more aggressive and frontloaded rate hike cycle. A half-point increase still looks likely in May. The meeting is 4 weeks from now. There’s a whole lotta space between then and now. Besides, the Fed doesn’t have a great track record of cooling things without forcing a recession. The Bond Market has been sending warning signals for a while. At 20 months and counting, this is the longest Bond Market decline in American history. We’ve avoided the Bond Market for a while. We are getting interested again.
The Stock Market has only recently been paying attention. Stocks do that. They like to ignore things until they no longer can. It’s not just a 2022 thing. Importantly, inflation like this has not been experienced for 4 decades. Most people in a professional position have not dealt with it before. There are so many external pressures at play, simultaneously. There’s a concern out there that the faster the Fed goes, the more they’re going to break.
Inflation Remains Public Enemy #1
Consumer prices increased a whopping 8.5% in March. It’s the highest since 1981. This marked the thirteenth month the Consumer Price Index (CPI) has been above the Fed’s longstanding targeted range of 2% per year. What the Fed used as a target for prices to climb in a year is happening pretty much every month. It’s going to be a while before we see 2% inflation again. A long while. Unless there’s more trouble ahead than the Market reflects.
With the Market, it’s all about expectations. It’s not really measured by good or bad. It’s more about better or worse. Things become less bad before they get good. The Market starts moving when things become less bad and immediately starts pricing in the good. The question isn’t when does Inflation peak? The question is, when does the Market price the peak in. High inflation was expected, and the Market has gone a long way to price it in the last few weeks. Importantly, the Core number which strips out food and energy came in at 6.5%. That’s still a high number. But it was less than expected. That fits the narrative of peaking inflation this Spring. Remember, Crude Oil hit $130 in March. It’s been straddling $100, up and down, for most of April. Volatility is nothing new to the price of Oil.
There’s been a scrambled mess of pricing pressures. Some call it a perfect storm for inflation: Russian invasion, surging Oil prices, China locking down, supply chain disruptions, and wage growth accelerating. Where is the inflation being felt the most, you might ask? The largest contributing factors are transportation, food and housing. These are the things that matter most to Americans. These combined categories account for 94% of current inflation. Prices were already on the rise, well before the war in Ukraine. It has completely exacerbated an already problematic situation.
Supply Chain Disruptions Are at Every Angle
It’s not just China’s lockdown that is slowing activity. Mexican truckers have been blocking a bridge across the Rio Grande in protest of Texas Governor Greg Abbott’s enhanced security operation. It has slowed cross-border commerce. Nearly $450 Billion in trade flows through the Texas-Mexico border each year. The Pharr-Reynosa Bridge serves as one of the most important ports of entry to America. 3,000 trucks cross the bridge every day. It’s also the largest land port for produce, including avocados, tomatoes, and broccoli. The delays resulted in roughly $30 Million of fresh produce sitting at the border. The Governor rolled back the security inspections due to major backlash.
Earnings Season; It’s on.
The Street is looking for 4.5% growth from Corporate America in the March quarter. That is down from the 5.7% anticipated just in January. This is actually the first downward revision in earnings since the Covid crash in 2020. Inflation and supply chain pressures will almost certainly dominate the commentary from management groups this Earnings Season.
JP Morgan is the Big Bank Bellwether. The company always leads things off. This go-around saw a swing and a miss. Both revenues and profits failed to meet Street expectations. Chairman and CEO Jamie Dimon is always outspoken and worth listening to. He tells it like it is. This week he said: “We remain optimistic on the economy, at least for the short term. Consumer and Business balance sheets remain at healthy levels.” Here comes the but… “But we see significant geopolitical and economic challenges ahead due to high inflation supply chain issues and the war in Ukraine.” Ok, maybe that wasn’t very insightful, because everyone knows that. But it underscores how unique and challenging the environment is in which we’re operating.
Consumer demand is still really strong. That was an important takeaway from JP Morgan’s report. The Big Bank said deposits and credit and debit card spending were all higher year-over-year and it continues to see increasing credit card spending on travel and dining. That’s a good signal for the re-opening of America. The problem is, more Dollars are being sucked away by inflation. When you consider that 40% of the American public has less than $1,000 in savings, that’s a big problem. The Fed knows this.
Dealing with High Prices
7 in 10 Americans surveyed believe the Economy is on the wrong track. They’re worried about their economic future. 75% of US drivers said in a survey they are already suffering financially due to high gas prices. 84% said they have already cut back in other areas, including clothing and dining out. That’s the risk for the US Economy, which is 70% Consumer Spending. It’s a major issue ahead of the midterm elections in November. With advice to those in Washington, Bill Clinton once said, “the American people don’t expect immediate results. But they better catch you trying…”
As inflation continues to soar across the country and around the world, even Amazon is trying to offset these higher costs. Fuel and inflation surcharges will now be tacked on to the existing fees the company charges its third-party vendors who use the Amazon fulfillment services. It’s basically storing, packing and shipping products for these small business partners. It’s estimated that 90% of Amazon’s 2+ Million sellers used Fulfillment by Amazon last year. It accounts for nearly one-quarter of Amazon’s total revenue, so it’s very material. Even the Tech Titans are passing the higher buck to its customers.
You don’t see this often, if ever. Elon Musk has been all over Twitter trying to buy Twitter. The company and Board don’t know what to do. It’s a fascinating situation. Friday, Musk posted, “I invested in Twitter as I believe in its potential to be the platform for free speech around the globe, and I believe free speech is a societal imperative for a functioning democracy. Twitter has extraordinary potential. I will unlock it.”
Elon Musk, the Tesla Founder, owns 9% of Twitter already, having recently purchased the shares. The stock remains elevated since Musk’s involvement. The offer to buy Twitter outright was framed as “Best and final.” This is where it gets tricky for Twitter management, employees and the Board. He left no room for negotiation. The Board has to do its due diligence, but if they don’t accept the offer, does Musk bail? The stock initially soared, but quickly gave those gains up and closed the week in the red. Late on Thursday, another offer was reportedly made by another potential buyer. It just got more interesting. The Musk offer of $54.20 might seem peculiar, with a random number named. But it seems highly intentional and completely consistent with Elon Musk. 420 means something. He likes that number. Google it if you’re curious to learn more.
Allies & Adversaries
The Dollar has been super strong. It’s been strong against pretty much every other foreign currency. When push comes to shove, it’s clear what the reserve currency is: The Good Old American Greenback. China doesn’t like it, but today, it doesn’t have much of a choice. China desperately needs Dollars. 88% of China’s global economic activity trades in Dollars. China imports a substantial amount of food, energy and basic materials because they don’t produce enough themselves. China is dependent on the rest of the world. That’s their vulnerability. China needs lower prices to provide for their people. They’ve gone higher. A potential food crisis will really hurt China. China’s grand strategy? It appears, with plenty of evidence to support, it’s manipulation for their benefit. China saw Russia as a tool for their benefit. That tool seems to have burned them a bit, but China won’t admit it.
It seems pretty clear that Vladimir Putin miscalculated the global response and the strengthened union of NATO as a consequence of his actions. Even Germany is moving away from Russian ties and increasing its spend and presence within NATO. But there are some things you might not be aware of. Germany is the largest economic power in Europe. That you probably know. Germany is also the European country with the strongest economic ties to our adversaries, namely Russia, China and Iran. Did you know that Former German Chancellor Gerhard Schroeder was recently named to the Board of Russian Oil company Gazprom? This happened just days before the Russian invasion of Ukraine. It’s true. Schroeder is also the Chairman of the Board of the Nord Stream company that operates the gas lines from Russia to Germany. Now, doesn’t that complicate things… The intertwining of relations and commerce make sanctions and reprimands so onerous on the global stage.
So where does that leave things, heading into this 3-day Easter weekend? We think this volatile price action has further to go. Strong consumer spending is quite encouraging as the re-opening of America continues. Pent-up demand to get out and about is like nothing we’ve seen before. But there are some longer-term implications for the pressures the Market faces. Inflation is the biggest economic challenge, and the Fed doesn’t have a great report card for cooling things without damage. The more we think about the current situation, it feels like we are reverting back to the 2018-19 cycle/framework. Back then, the Economy was slowing, the yield curve inverted, and everything was abruptly disrupted by the Coronavirus lockdown in 2020. Unprecedented stimulus from the Fed and Congress propped things back up, but now that stimulus is burning off and reversion to 2019 cycle end is back. It’s a normal cycle which was abnormally interrupted by a global pandemic. It’s important to remember, cycles are normal. Corrections and Bear Markets are part of the cycle. That’s what we think this is. We just need to keep fighting through and playing strong defense, which we are. 2022 is about survival. We are.
Have a nice weekend. The Market is closed tomorrow in observance of Good Friday. Happy Passover and Happy Easter. We’ll be back, dark and early on Monday.