Is The Bottom Almost Here?

[mattee2264]

It is a strange dynamic.

 

In a market dominated by growth stocks recession is pretty bullish as it means lower interest rates and it also helps that AI helps investors project dazzling future growth rates which helps them overlook that recent earnings have been pretty disappointing. 

 

The old economy stocks (financials, retail, commodities, housing etc) are selling off in anticipation of a recession and are down 30% or more from the highs. But they aren't important enough to make a massive difference. Even during COVID when they were still at multi-year and in some cases multi-decade lows the market was back above 3000 by the summer simply because investors had crowded into technology stocks.

 

And it seems a similar dynamic. Instead of embracing 5% bonds as safe havens investors are loading up on Big Tech priced at 30-40x earnings. 

[John Hjorth]

4 minutes ago, mattee2264 said:

It is a strange dynamic.

 

In a market dominated by growth stocks recession is pretty bullish as it means lower interest rates and it also helps that AI helps investors project dazzling future growth rates which helps them overlook that recent earnings have been pretty disappointing. ...

 

... And it seems a similar dynamic. Instead of embracing 5% bonds as safe havens investors are loading up on Big Tech priced at 30-40x earnings. 

 

@mattee2264,

 

Please remember, this is about the marginal buyer [, in the meaning : not you, nor for that sake me, if we are discarding those prices]. In short, they don't matter that much, if you don't feel inclined to engage.

[changegonnacome]

 

Larry saying what I've been saying for months - take the 9% inflation rate peak.......and the mistake folks are making is that about 50% of that peak rate was indeed transitory it just took longer than some expected to roll off....but it did....we've enjoyed a nice linear journey from 9% down to 5%......folks are extrapolating the progress from 9 to 5 as indicative of the ease by which we will travel from 5 to 2....the issue is the other 50% of that 9% inflation rate (the underlying inflation) is not transitory......the rubber is hitting the road now as we start to hit this sticky inflation......sticky because its been driven by nominal wage increases that are feeding into nominal spending growth that is exceeding productivity growth.  Its clear to effect the equation which is driving this 4% sticky underlying inflation that hasn't moved a jot in months that the labor market will need to get hit. So the question isn't if this will happen, the Fed can through its ability to set the most important number in the economy slow it....the question is rather when.

 

The easy inflation progress 9% to 4.5% is about to run out of steam very soon....4.5% to 2% is gonna be a bitch.......don't see many talking about rate cuts in September anymore.....quite the opposite....another raise is coming in July (if not June).

 

Edited June 4, 2023 by changegonnacome

[changegonnacome]

Another little counter to the "sea change" argument as regards post inflationary period interest rates returning to ZIRP like levels......is the below R-star model that the NY Fed's John C Williams has just restarted post-COVID craziness: 

Speech: https://www.newyorkfed.org/newsevents/speeches/2023/wil230519 

R-star Forecast - https://www.newyorkfed.org/research/policy/rstar

 

Listen crap in, crap out models have problems......but if the RStar model is to be believed....once inflation is 'fixed'.....there isn't anything in the model right now to suggest that we need  substantially structurally higher interest rates on the far side of this inflationary bout. Guess you could add the productivity miracle that LLM's might spur and you've got strong disinflationary forces supporting a return to ZIRP. Driving inflation & structurally higher interest rates in response you've got the slow moving 're-shoring' trend............ & the energy transition which will require gobs and gobs of capital to complete.

[Gregmal]

On 6/2/2023 at 12:24 PM, TwoCitiesCapital said:

Versus a 20+ multiple on contracting earnings from stocks that have spent two years absolutely failing to be inflation hedges? 

I keep seeing this said matter of factly but have never seen why this isn’t better defined and the cherry picking explained?
 

All of last year we heard this sort of thing stated as if inflation started in Q1 2022….which I can pretty confidently say, it did not. The post COVID inflation by all accounts started probably summer 2020. During this time period, there are absolutely tons of stocks you would have been fine owning. If you owned bonds you have pretty much nothing to show for that entire period. Even just broadly, the stupid index, SPY was at 3200 in July 2020, 4100 July 2021, 3800 in July 2022, and today sit a bit over 4200. This “stocks are bad inflation hedges” seems like a conclusion a lot of people really badly “want” to be true, but even in the best possible environment for trying to prove this to be the case, the case is pretty poor and actually showing why you want to own stocks for the long haul. 

[gfp]

On 6/2/2023 at 5:27 PM, changegonnacome said:

.we've enjoyed a nice linear journey from 9% down to 5%......folks are extrapolating the progress from 9 to 5 as indicative of the ease by which we will travel from 5 to 2....the issue is the other 50% of that 9% inflation rate (the underlying inflation) is not transitory......the rubber is hitting the road now as we start to hit this sticky inflation......sticky because its been driven by nominal wage increases that are feeding into nominal spending growth that is exceeding productivity growth.  Its clear to effect the equation which is driving this 4% sticky underlying inflation that hasn't moved a jot in months that the labor market will need to get hit. So the question isn't if this will happen, the Fed can through its ability to set the most important number in the economy slow it....the question is rather when.

 

The easy inflation progress 9% to 4.5% is about to run out of steam very soon....4.5% to 2% is gonna be a bitch.......don't see many talking about rate cuts in September anymore.....quite the opposite....another raise is coming in July (if not June).

 

https://fred.stlouisfed.org/series/T5YIE

 

You are looking in the rear view mirror.

 

Also, the Federal Reserve is next to powerless when it comes to inflation - in either direction.  If anything, they are increasing inflation with their current policy rate.

[Gregmal]

Yea I still laugh at the idea rates solve the housing problem, which is the biggest driver of inflation….it costs folks $5k a month to own a $500k home now lol Thanks Jerry 

Edited June 4, 2023 by Gregmal

[gfp]

36 minutes ago, Gregmal said:

Yea I still laugh at the idea rates solve the housing problem, which is the biggest driver of inflation….it costs folks $5k a month to own a $500k home now lol Thanks Jerry 

And froze out so many existing homes from coming on the market.

[changegonnacome]

18 hours ago, gfp said:

https://fred.stlouisfed.org/series/T5YIE

 

You are looking in the rear view mirror.

 

I look out the front window too...5-year break even is half the story........the question from the 5-year break even is why is the bond market so confident inflation is going back to normal?.......I suppose there's those who think employment doesn't break and we've no or an ultra mild recession & we magically get back to two.  The immaculate disinflation camp.

 

The only problem is your 5-year break even that your taking comfort in....is imputed by the same bond market participants that create the LIBOR/SOFR forward curve (below)...........if you believe in one, you should believe in the other......the forward curve is sign-posting a recession and not a mild one......mild recessions don't force the Fed to cut as aggressively as the forward curve implies.

 

The bond market is saying that this inflationary bout doesn't end in a whimper, it ends in a scream.

 

 

[gfp]

Yes, exactly.  The forward SOFR curve is predicting deflationary recession.  Something so bad the Federal Reserve would be forced to cut overnight rates and cut them fast.  I don't know why you think that predicts sticky inflation.  That is deflation. 

[Gregmal]

At Costco this morning and they’re basically giving away appliances. Remember when appliances were proof of the sticky inflation? This has all been so predictable. Things that never were hard to produce didn’t become structurally harder to produce. Turns out the “productivity” of the factory workers at LG and Whirlpool wasn’t a big deal either. They just needed the supply chain to get fixed.

[changegonnacome]

1 hour ago, gfp said:

Something so bad the Federal Reserve would be forced to cut overnight rates and cut them fast.  I don't know why you think that predicts sticky inflation.  That is deflation. 

Sticky in respect that its removal will require force…..non-sticky inflation just goes away on its own. Immaculate disinflation or the soft landing camp.

 

The 9% to 5% inflation journey was a cakewalk…it was immaculate & soft…however that portion was transitory inflation, it was “non-sticky”….5% to 2% inflation however…is sticky in the sense that the backdrop to this portion of the disinflation journey requires falling nominal spend, rising unemployment and negative GDP. Mainly because this portion of inflation is being driven by an over-heating domestic economy…operating beyond its natural equilibrium and constrained by demographic & labor force realities….in essence growing nominal spend substantially quicker than its growing real goods but mainly services.

 

So guess we are saying the same thing - when I say sticky….I don’t mean it’s never go away but rather it’s not going away with zero pain.

[changegonnacome]

11 minutes ago, Gregmal said:

Remember when appliances were proof of the sticky inflation?

Assuming these said appliances got on shipping containers and I’m sure they did - you might remember me saying six months ago that Made in China/S.E Asia inflation was going away (Goods) but made in America inflation (services & domestically produced goods I.e. SuperCore) was not.

 

Ultimately that’s exactly where we’ve ended up….complete non-movement on SuperCore inflation happening contemporaneously MoM…. The reality of which is  pointing to the Fed to resume rate hikes beginning in July, or even as early as June.

 

SuperCore will go away too - don’t get me wrong - but you won’t like what’s happening in the real economy & to US equity indexes while it does.

[mattee2264]

What's incredible is that Microsoft and Apple together account for almost 15% of the S&P 500 by market cap and adding the other Big Tech companies you easily get above 25%. Any rebalancing of the index driven by the 2022 bear market that fell most heavily on Big Tech names has gone into reverse and we are more concentrated than ever. And most of the Big Tech names are back trading close to or even above the end of 2021 highs even though interest rates are over 400 bps higher with an average multiple of around 30-40x earnings.  It reminds me a little bit of the tech melt up during the COVID recession with tech viewed as a safe haven. 

 

In any case it is hard to make a case for the market revisiting last year's lows unless Big Tech takes another big tumble. 

 

 

[Spekulatius]

1 hour ago, mattee2264 said:

What's incredible is that Microsoft and Apple together account for almost 15% of the S&P 500 by market cap and adding the other Big Tech companies you easily get above 25%. Any rebalancing of the index driven by the 2022 bear market that fell most heavily on Big Tech names has gone into reverse and we are more concentrated than ever. And most of the Big Tech names are back trading close to or even above the end of 2021 highs even though interest rates are over 400 bps higher with an average multiple of around 30-40x earnings.  It reminds me a little bit of the tech melt up during the COVID recession with tech viewed as a safe haven. 

 

In any case it is hard to make a case for the market revisiting last year's lows unless Big Tech takes another big tumble. 

 

 

Why do you think big tech can’t take a tumble from here? The big tech rally is not underpinned by fundamentals, Imo.

[mattee2264]

My basic reasoning is that

 

a) The tech bear market was last year driven a hawkish Fed and the inevitable disappointment in results compared to the bonanza revenues and earnings achieved during the pandemic

b) Even if the economy goes into recession this will further encourage a rotation into tech which given the current index composition is neutral to bullish for the market level. Reason for the rotation is a) tech is seen as less economically sensitive b) a recession could mean a pause/pivot which means lower discount rates which is good for long duration growth stocks 

c) AI means more growth options and cloud is likely still in relatively early innings at all. So this should ease concerns that Big Tech are becoming mature and therefore their days as growth stocks are behind them

d) The quick reversal of the large losses last year increases confidence that any dips are buying opportunities and Big Tech are unstoppable 

 

Personally I do find 30-40x earnings a bit rich for my blood for trillion dollar market cap companies that by law of large numbers and basic economics will struggle to grow at double digit rates going forward. Especially as interest rates are 5% and higher. But the lesson from this bull market has been that you can't go wrong owning Big Tech and it seems more likely to me they will go sideways over the next decade but not necessarily fall off a cliff the way the Nifty Fifty bull market and dot com bubble ended and therefore I think the market will probably follow suit and go sideways with modest volatility for the foreseeable future unless of course AI goes from being a mini bubble to a massive bubble 

[Spekulatius]

@mattee2264 the FED hasn't really changed and in fact the rally occurred during a time when LT interest rates increased, which to me seems concerning. I think the rise in tech is due to AI hype where I think we will see very little revenue impact the next few years, except NVDA and perhaps AMD which see improved demand for their chips.

 

However one has to consider that NVDA's and AMD's  revenues are another companies expenses.

 

Anyways, I am reducing some exposure to tech names where I bought the dip (GOOGL, ZS).

[tede02]

1 hour ago, Spekulatius said:

@mattee2264 the FED hasn't really changed and in fact the rally occurred during a time when LT interest rates increased, which to me seems concerning. I think the rise in tech is due to AI hype where I think we will see very little revenue impact the next few years, except NVDA and perhaps AMD which see improved demand for their chips.

 

However one has to consider that NVDA's and AMD's  revenues are another companies expenses.

 

Anyways, I am reducing some exposure to tech names where I bought the dip (GOOGL, ZS).

 

I share most of this sentiment. AI definitely seems to be a new story people are excited about and I'm not sure we even know what the business model looks like. NVDA is selling for over 30X SALES! LOL. I bought a tiny amount of long waaay out of the money puts for amusement. 

[changegonnacome]

5 hours ago, Spekulatius said:

Why do you think big tech can’t take a tumble from here?

 

My base case is they tumble from here......the ones that are economically sensitive and exposed to a hard landing for sure. This feels like a wonderful and surprisingly elongated bear market rally. In some ways the length of the bear market rally is a function of how long its been since we actually had a bear market (08/09)......the Pavlovian response of buying the dip has been taught to the dog for 14 years...its hard to undo deeply ingrained neural pathways.......you could argue the training has been in place since 1981 when long term bond yields started their four decade long secular fall.......literally a whole career in equity investing could have passed with the long term bond yielding less and less over time.....what a wonderful tailwind.

 

Certainly feels like H2 is going to get very choppy for markets I think as either (a) the Fed gets what it wants and things start to deteriorate with the economy from a fundamental basis or (b) things don't deteriorate..........and the Fed is forced to get surprisingly aggressive with an incremental wave of hikes. Either way the 'no landing' dream goes out the window.......and what emerges are questions around the severity of the coming recession.

 

I remain convinced that 4.5% inflation can only be brought back to 2% with a fundamental weakening of the economy something in the vicinity of ~5% unemployment rate (but more likely 5.5% just given Sahm rule) & negative GDP. The only question I have left is given the demonstrated rate insensitivity of the US economy has the Fed done enough at 5% FF or does surprisingly high to get the labor market to roll over. I'm leaning towards higher and 6% FF.......50bps in July as little excercise in shock and awe....and if the data doesnt start to weaken in late summer/fall in response then another 25bps in September & October.

 

The FF rate isnt the point.....the point is they are determined & a little surprised by the resilience of the US economy to date......and as a central banker it must be quite alarming to be almost a year and half into this.......and to realize that underlying domestic made in America inflation (SuperCore) has not shifted one little bit after 500bps of hikes!

 

One thing is clear.......unlike the Chinese consumer........the American consumer spends like a drunken sailer on shore leave......when you think about putting your economy into a central bank induced coma you've got to worry about your ability to bring the patient back to consciousness i.e. spending again.......there should be no such worries here.......in Europe it can be very hard to get the patient to wake up after a spending coma......and I think the Chinese live in fear of their savings rate spiking & domestic consumption plummeting.

[mattee2264]

A friend shared a crazy chart with me. 

 

From end of last year Big Tech (META,AMZN,AAPL,MSFT,GOOGL,TSLA,NVDA) are up 53%, S&P 500 is up 11% and the remaining 493 companies are essentially flat over the last six months or so. 

 

 

[TwoCitiesCapital]

1 hour ago, mattee2264 said:

Personally I do find 30-40x earnings a bit rich for my blood for trillion dollar market cap companies that by law of large numbers and basic economics will struggle to grow at double digit rates going forward. Especially as interest rates are 5% and higher. But the lesson from this bull market has been that you can't go wrong owning Big Tech and it seems more likely to me they will go sideways over the next decade but not necessarily fall off a cliff the way the Nifty Fifty bull market and dot com bubble ended and therefore I think the market will probably follow suit and go sideways with modest volatility for the foreseeable future unless of course AI goes from being a mini bubble to a massive bubble 

 

Do you have any examples of stocks that traded sideways into their valuation as opposed to down/up? 

 

Just curious how often it happens, because I think the way human psychology works is to lend itself to the cyclicality and NOT stability of price. 

 

For the last decade what supported tech was the argument of 0% rates and TINA as well as reversion to higher multiples from 2008-2011 type lows. But now there are alternatives and the cost of capital is the highest it's been in 15 years....seems to me that people will try to grasp onto ANY reason to continue to support those valuations because the original thesis is no longer true and we're looking at 30-50% corrections in a lot of these names otherwise. Once people realize there isn't anything left to grasp on to, I expect you get a downdraft. 

 

 

Edited June 6, 2023 by TwoCitiesCapital

[changegonnacome]

This feels about right in terms of a summary of where we currently are :

Edited June 6, 2023 by changegonnacome

[gfp]

Well I agree that "Quantitative tightening" doesn't matter, Tech almost always has a rich valuation and "bank deposit outflows" doesn't matter.  No clue what LEI is so that probably doesn't matter either (number of legal entities that exist at any given time??)

[Gregmal]

6 minutes ago, changegonnacome said:

This feels about right in terms of a summary of where we currently are :

 

 

 

 

 

Well the underlying thing we see over and over again is a bunch of people thinking they’re smarter than the market. That’s never really worked and I don’t expect it to anytime soon. These people would be better off just admitting that they don’t know shit and just stick to their knitting. But humble they are not.

[TwoCitiesCapital]

46 minutes ago, gfp said:

Well I agree that "Quantitative tightening" doesn't matter, Tech almost always has a rich valuation and "bank deposit outflows" doesn't matter.  No clue what LEI is so that probably doesn't matter either (number of legal entities that exist at any given time??)

 

LEI = leading economics indicators

 

Two, I'd say deposit outflow ABSOLUTELY matters. Liquidity constrained banks don't make ad many loans. And the loans they do make are much more rigorous in credit protections to ensure they're money good. 

That slows down the flow of credit and thus the flow of money through the system. 

 

Fewer dollars circulating= fewer dollars spent = fewer dollars of earned income.

 

Also tends to mean people focus on deleveraging instead of investing for future growth/profits moving monies to banks/creditors where it remains static as excess capital versus moving through the economy. 

Edited June 6, 2023 by TwoCitiesCapital