Discover more from Banking on the Market
The Weekend Edition # 22
FOMC & Econ Data Takeaways, Sector - The Financials, Earnings - ADBE, RIVN, FDX, The Ark Note, Closing Thoughts - Tried & True vs Innovation
Welcome to another issue of the Weekend Edition.
Thank you to all who’ve read and subscribed to the newsletter this week. I am very grateful!
Now, let’s grab a cup of coffee ☕️, while we take a look at what happened in the markets this week.
Here’s what we cover:
Market Recap - FOMC, PPI, Retail Data, Housing Data, Curve Flattening
Sector of the Week - The Financials
Earnings brief- Adobe, Rivian, FedEx
Around the Markets - The Ark Note
The Week Ahead
Closing Thoughts - Tried & True vs Innovation
Let’s dive in ⬇️
Market Recap - Dec 13 - Dec 17, 2021
We knew the markets were going to be choppy this week because of the Fed meeting and all the other economic indicators coming out this week, not to mention quadruple witching on Friday. The market indices closed down for the week falling below the 50-day moving average, with the Vix increasing back up over 20. The Russell continues to take quite the beating, now 5% below it’s 50-day MA.
Despite some hint of a rally after the Fed Announcement of a faster tapering, the market still remains under pressure with only 46% of NYSE stocks above their 200 day moving average, while for the Nasdaq that number is a dismal 26.48%. We thought we smelled a Santa Rally coming on. Not quite yet!
The Yield Curve still remains quite flat, and this was one question that was asked during the Fed press conference, to which Fed Chair Powell responded that he’s not troubled by the rate in long bonds. Longer-term bond yields still remain attractive compared to other countries and therefore, funds are flowing to these bonds pushing prices up and pulling yields down. This is still a concern, particularly if short term rates go up faster than long term rates. This is something we covered in Edition 15 and Edition 16.
Key Takeaways from the Fed Meeting (they’re getting more educational)
Tapering speed accelerated from mid-Jan to $20B in treasuries and $10B in mortgage-backed securities which means the end of tapering by Mar 2022.
Median projection for real GDP growth is 5.5% for this year and 4% for next year
Median projection for unemployment rate declines to 3.5% by the end of this year
Median projection for the Federal Funds rate is 0.9% by the end of 2022, about 0.5% higher than that projected in September. [This signals about 3 rate hikes next year]
The decision and discussion to taper was 10 days before the Fed Chair’s re-nomination and Powell’s hawkish stance had nothing to do with his re-nomination. (At least he addressed that!)
No decision on rates has been made as yet. If growth slows and inflation reduces faster than expected, they will adapt accordingly.
Maximum employment goals would have to be reached before a firm rate decision can be taken, which means unemployment, wages, labor force participation all have to be at the right levels for a rate decision.
So basically, while the market is pricing in 3 hikes next year, the Fed’s official stance still remains a “wait & see” on rate increases. One possible reason for this is that some of the inflation is caused by supply chain disruptions and not necessarily monetary or fiscal policy. The disruptions are in turn, caused by Covid waves, which still remains an uncertain piece of the puzzle.
Other Economic Data for the Week
PPI numbers increased to 9.6% YoY with Core PPI numbers at 7.7% YoY (this is excluding food and energy). The energy numbers increased 2.6% MoM, which is significant since there was already a monthly increase of 5.3% in Oct. Unprocessed goods increased 4.8% - yet more evidence of inflation in raw inputs due to supply chain disruptions.
Retail Sales for Nov increase 0.3% MoM which was much lower than Oct’s increase of 1.8%. Motor vehicles & parts sales actually dropped by 0.1% in Nov compared to the 1.7% increase in Oct. The lower retail sales number is quite likely the result of early holiday shopping in the previous month to avoid shipping delays.
Total Industrial Production increased 5.3% YoY, the highest since Sep 2019. Auto assembly increased 3.5% MoM to an adj. annual rate of 9.35m units. This is strong data that shows there’s enough pent up growth and demand.
Housing Data came in positive with increases in both Housing Starts (+11.8% MoM) and Building Permits (+3.6% MoM). Single Family units saw the most increase. New supply will lend some ease to the tight housing market, reducing prices.
Sector of the Week - Financials
We all know that rising rates help the financial sector. Banks tend to borrow or take deposits at short term rates, while they usually tend to lend at long term rates.
So as liquidity tightens and bond rates are set to increase, the financial sector should benefit from rising longer term rates. Further, we expect at least three rate hikes now for next year. Unless the yield curve flattens too much or inverts, banks should be in good shape.
Even if the curve inverts, larger banks tend to do okay because of their fee income. Apart from this many banks also pay dividends and they tend to be stable solid investments.
You could buy ETFs that cover the financials like XLF, FAS, VFH, KRE, IXG, IYG, IYF, to name a few.
Or you could look at the top banks and consider one or two names. Most banks have performed well this year, except Citi. They’ve had their own challenges with growth.
If long term rates rise, ideally you would look at a bank that has more exposure to Interest Income instead of flat fees. Most investment banks charge more fees such as Goldman Sachs and Morgan Stanley. You would also want to look at a bank with lower loan loss provisions.
The chart above shows you that BAC has the lowest loan loss provisions among the Diversified Banks, followed by WFC. BAC, WFC, C and JPM all have sizable exposure to interest income.
Comparing a few more metrics, BAC is the most expensive in terms P/E, Forward P/E or PEG. In fact, the sector median is 10.98. However, BAC remains the only commercial bank with positive quarterly revenue growth. One important consideration for banks in the ROCE - Return on Common Equity. As far as this measure is concerned, BAC seems to be the worst.
Personally, I own FAS, which is the Direxion ETF for Financials but is 3x leveraged, which makes it a very risky investment. And for individual stocks I own some Morgan Stanley and Bank of America, although in smaller proportions to FAS. As always, if you’re going to buy an ETF, please do remember to look at the holdings to make sure you know what you’re buying.
Earnings of the Week
Adobe had the second largest drop in share price in its history, after the Covid crash despite posting in-line results. Results were seen as a disappointment for a company benefitting nicely from the pandemic posting huge beats during the last few quarters. While all their segments actually grew YoY, the Cloud Segment was the winner at +29% vs +21% for the previous quarter. Adobe suffers the same fate as Docusign, Zoom and Teledoc, all perceived as “pandemic winners”, unfortunately. I don’t think this is right. Each have their strengths and should continue to grow even through the re-opening.
It’s no surprise, Rivian didn’t deliver what they were supposed to. For a “new” EV maker to start and ramp up production during a time of supply chain disruptions would definitely be a massive challenge. As of Sep 2021, they delivered 11 R1 Trucks booking sales of $1million. The Company produced 615 trucks as of Dec 15, 2021, initially forecasting production of 1200 trucks for the year. Still, they have pre-orders of 71000 for the R1 truck, which will all likely be delivered by 2023/2024. They are also focusing on their Electric Delivery Vans for Amazon, who’d placed an order for 100,000 vans and have also invested in them. Rivian also announced a new facility in Georgia which will have an annual production capacity of 400,000 EVs.
FedEx got a nice price boost after delivering an excellent set of numbers for Q2, 2021. After a disappointing miss in Q1 because of staffing issues, the company hired over 60,000 frontline workers during Q2 to cope with the holiday season and they intend to retain most of the workers. Further, international export demand in Europe and APAC has made a full recovery to pre-pandemic levels.
Around the Markets
Cathie Wood & Ark Invest released an interesting note this week. I’m sure most people with any interest in growth stocks have read it. Besides mentioning that they hope to achieve a 40% CAGR on their funds over the next 5 years, they also mention some interesting themes:
Deflation - they’re convinced that the biggest issue we face in the coming few years is not inflation but “good” deflation. Anyone who knows Cathie Wood, knows that she’s held on to this belief firmly for the last few months / years. Her logic is that the pace of innovation will far oustrip any inflationary factors.
Deep Value - they believe that growth stocks have entered into deep value territory after 11 months of correction and that these stocks will ultimately grow exponentially because of their investment in cutting edge technology.
They also hit back at the investing public for taking a routine “Pavlovian response” to inflation and rising rates by rotating out of growth stocks and moving to value. According the the note: “They are backward-looking and do not recognize that companies investing aggressively today are sacrificing short term profitability for an important reason: to capitalize on an innovation age the likes of which the world has never witnessed.” Ouch!!
On disruptive innovation - “Based on the last eight years of our research, the opportunities will scale from $10-12 trillion today, or roughly 10% of the global public equity market cap, to $200+ trillion during the next ten years.”
The Week Ahead
Shorter Week for Christmas - Trading will be closed on Dec 24, 2021
We know the market is changing. It will likely be harder to make outsized returns from just any stock next year. We’ve had an amazing run for the last two years and now we go back to being a bit more cautious. We go back to actually trying to learn about investing and trading… doing things the right way.
On the one hand, we have the tried and true - rotation to defensive industries, financials and what has always worked. The Palovian repsonse, as Ark calls it.
On the other hand, we have people like Cathie Wood telling us, growth doesn’t have to be dead. Personally, I have tremendous respect for Ms. Wood and her excitement surrounding innovation.
I completely agree with her concept of being on the right side of change and adapting to new technology. Imagine what would’ve happened if we’d all decided that landlines were enough and that no one needed phones to be portable.
I know her funds are not doing as great as they were last year but, that’s not to say that she won’t be right in 5 years or 10 years. I don’t know about the 40% CAGR but they do a lot of great research and they certainly have identified a few solid names.
I’m happy to buy (or sell) whatever makes me money.
Here’s wishing you a happy weekend and safe investing… and Merry Christmas!
Ayesha Tariq, CFA
There’s always a story behind the numbers
None of the above is Investment Advice and all views are personal. I may or may not have positions in any of the stocks mentioned. I have a long position in $FAS, $BAC, $MS, $DRI as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.