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The Weekend Edition # 25
So What did the FOMC minutes say?; Earnings - Walgreens Boots
Welcome to another issue of the Weekend Edition.
Thank you to all who’ve read and subscribed to the newsletter this week!
This week we cover:
Market Recap and Economic Data
Macro - So What did the FOMC minutes say?
Earnings - Walgreens Boots ($WBA)
The Week Ahead - Event Calendar
Closing Thoughts - Earnings Season starts next week
Let’s dive in ⬇️
Market Recap - Jan 3 - Jan 7, 2022
What a week we’ve had. All the broad market indices were negative for the week under substantial selling pressure led by the growth stocks. Not the best way to the start the year and certainly no hint of the January Effect that I discussed last week.
It’s troubling that most of the indices closed below their 50-day moving average with only the Dow barely above. Earlier in the week we had comments from several Fed members about a possible balance sheet reduction or quantitative tightening and the FOMC meeting minutes on Wednesday certainly didn’t help. The minutes show that these measures have been suggested to curb inflation and this sent the market running for the hills. (We look at the meeting minutes in detail below, after the market recap.)
The long end of the curve is lifting, which is good in one way because the curve is now steepening. From a sector perspective, Energy and Financials did very well, which is expected given the possibility of rate hikes.
Berkshire Hathaway (BRK), Bank of America (BAC) and Wells Fargo (WFC) all hit new highs. I’d written about taking possible exposure to the financials in mid-December (if you want to take another look).
Economic Indicators Round-up
The economic data this week showed the some pressure from the Covid situation:
Manufacturing & Non-manufacturing Data -
The ISM Manufacturing Index decreased to 58.7% from 61.1% in November. But what was very interesting is that there was a sharp decrease in the price index from 82.4% to 68.2% indicating some improvement in supply chain conditions.
The ISM Non-Manufacturing Data for December also decreased to 62% from record highs of 69.1% in December.
Anything above 50% still indicates expansion
Jobs Data - A mixed Jobs Data this month with the Unemployment rate reducing to 3.9% from 4.2% in the previous month but with nonfarm payroll also decreasing to 199K from 210K in the previous month. The labor force participation rate remained unchanged at 61.9% but average hourly earnings increased 0.6% vs. 0.3% for the previous month.
Given the fall in the unemployment rate, the Fed’s decision to hike rates becomes even more viable.
Macro - So what did the FOMC minutes really say?
Here’s some of the key points:
Changes to the Fed Fund Rate should be the primarily tool for normalization because the effects of changes are more predictable and more familiar to the general public.
Almost all participants agreed that it would likely be appropriate to initiate balance sheet run-off at some point after the first increase in the target range for fed funds rate.
They also noted that current conditions could warrant a potentially faster pace of policy rate normalization.
There were some comments about using balance sheet reduction more than policy rate adjustment to limit the flattening of the yield curve. [Recall, if the Fed hikes rates too fast, a flat curve could even invert]
The median respondent's projected timing for the first increase in the target range for the federal funds rate also moved earlier from the first quarter of 2023 to June 2022.
There are two basic issues, which are actually interconnected:
Inflation is out of control and needs to be curbed. The rise in inflation has overtaken any rise in wages and savings.
The level of liquidity or “cash” in the market has increased to very high levels. This is no longer required and its created bubble-like situations in the stock market and the housing market.
Will the Fed Raise Rates?
Yes, they have to. This level of low rates is not sustainable. Most are thinking that the rate hike will come soon after the tapering end in March, although the median consensus was June.
Will they sell off their bonds, i.e., Quantitative Tightening (QT)?
However the real questions are:
How soon? How fast? and, How much?
And I see this depending on the following:
Covid subsiding ➡️ Inflation Subsiding - If Covid persists, it will cause more labor shortages and further supply chain disruptions, keeping the level of inflation high. However, if these issues resolve soon, inflation should subside to a certain extent automatically so the Fed may not need very aggressive measures.
The Automatic run-off of the Balance Sheet - As the Fed minutes highlighted, a major portion of the Assets on the Fed Balance Sheet is short duration which could run off as they start to mature. In which case, it will have the same effect of shrinking the balance sheet.
Government Spending Policies - Midterm Elections - There are a few political factors at play here. And most people are of the opinion that the Fed’s decision may be driven by political factors. Be that as it may, the Fed has been known to take a stance to the contrary. So we’ll just have to see.
The first FOMC for 2022 is Jan 25-26. We’ll know more then.
Earnings of the Week
This was like pre-earnings season with a few very solid earnings report. We’ll look at just one very quickly.
Walgreens Boot Alliance (WBA)
A solid quarter from the pharmacy chain with increase in same-store sales and forward guidance at 4% revenue growth
The company also announced plans to increase its stake in AllianceRX from 55% to 100% stating it would be easier to restructure the company under one owner. Earlier, WBA had noted that AllianceRX would be the main driver behind an 8% drop in US revenues so, increasing ownership wasn’t really a welcome move.
International is still looking challenging with foot traffic still 20% below pre-pandemic levels.
Their $5.2B investment in VillageMD, a primary care offering, will still be one to watch.
The Week Ahead
Wed Jan 12, 2022 - CPI and Core CPI data (Inflation indicator)
Thu Jan 13, 2022 - PPI & Core PPI data (also Inflation indicator)
Fri Jan 14, 2022 - Retails Sales Data; Sentiment Data
Earnings season is upon us, yet again. How companies will report will have an even more important effect on the market. We’ve been in a beautiful bull market where earnings have consistently propelled companies higher.
This time however, companies will be watched more closely for a number of reasons:
We still have supply chain problems coupled with wage increases due to shortage of labor. Companies’ profit margins have been under pressure from higher costs. This is what I examined throughout the last earnings season.
For most companies this is the Q4 or Full Year performance and will set the tone for the next year. We will see if the increase in earnings for companies justify valuations. I’m quite sure the market will be very unforgiving in this tighter environment so, trading around earnings is no longer a safe bet.
We will also see how the micro drives the macro and vice versa. Companies that are strong will likely be more resilient going into a tight macro-environment.
Challenging times are ahead. But that doesn’t necessarily mean a crash. However, I get the sense that the market still remembers what happened during the last rate hiking cycle, since it wasn’t too long ago and many are therefore, forecasting a bear market.
Nevertheless, even in the worst of time, there are companies that grow and do well. The key will be to look at those pockets of strength for the short to medium term & pick up great companies and reasonable prices for the longer term.
Here’s wishing you a happy weekend and safe investing.
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 no affiliation with any of the companies that are mentioned.