AM Brew, June 7th 2022

We have been talking about range bound markets for a while now, and yesterday we quantified the "Upper Range" above 4,150 on the S&P, which seemed quite accurate all day as the market traded off twice when it hit that range. Stock futures are down approximately -80 basis points across the board in London morning trading. The current "valuation matters" markets are likely to continue until we start getting new data with earnings releases - to reiterate yesterday's thoughts, between the range of 3800 to 4250, there are buyers below 3900 and sellers above 4150.

In typical bear market fashion, some takeovers look shaky: Musk is wavering on Twitter, as he overpaid a bit & a few bidders have bowed out of the sale of British retail chain Ted Baker, which is down -20% on the news. Not all news in takeover land is bad, as JetBlue increased its offer for Spirit Airlines. Kohls jumped 12% as its in talks with a potential acquirer. In general, capital market activity is weak with no IPOs and some broken acquisitions.

Bitcoin is down -6%, trading again below $30,000. Bitcoin's pattern of down during the week and up on weekends is not good for crypto - before getting bullish on crypto, we would want to see healthy Monday-Friday action.

Reuters is reporting that Asian equities are approaching March 2020 levels, with the MSCI Asia Pacific Index trading at 12.6x forward earnings as of the end of May. An index trading at those levels is certainly attractive and is a meaningful discount to US markets and also an indication of how bad things could get in a prolonged bear market.

Goldman said that a 400,000 barrel oil deficit is likely given China's re-emergence and that oil would need to go to $135 to spur enough production to cover the deficit. This scenario is looking increasingly likely ( but no idea what the percentages are ) and this scenario would almost certainly bring $7 gasoline to most of California. Fortunately oil markets are quiet this morning, but there are no visible signs of easing. Energy will ease when production rises significantly, but there are no indications that this is happening. Biden & the Democrats are in a tough spot because if they ease taxes on new oil drilling, they fix the energy problem but they will create a permanent legacy of favoring the short-run economy over the long-run environment. Tough spot, we don't envy them.

Today's $44 billion 3-year note auction is the first without Fed support. Yesterday's rise in rates was quite negative and it looks like rates are climbing again. Since we don't know if we are in a transitory 8% inflation or a longer-run 4% inflation environment, its hard to say where "value" is in the fixed income market. Certainly 10 year bonds at 3% to 5% is not value, we know that.

Bloomberg is reporting some good news on the inflation front, with contract DRAM prices down 14% versus last year, spot rate shipping containers down 26% since September and North American fertilizer prices down 24% since March. Given the aggregate data, our current feeling is that the Fed has contained the runaway across-the-board inflation and we are in a bifurcated market with many prices falling and many prices still rising.

Peleton shares rose 1.4% in after-hours trading yesterday as they appointed a new CFO from Amazon Web services. We prefer to fade moves like these. How easy is it to turn in good results at AWS? Buffett said it best: "when a manager with a reputation for brilliance is put in charge of a company in an industry with a difficult reputation, its the reputation of the industry that will prevail".

Bloomberg had a nice chart showing 50 years of history of recessions versus capacity utilization. The US economy has never gone into recession with capacity utilization rising, like it is now:

With the yield curve steepening, high-end retail sales strong, and earnings still ok, Bloomberg is arguing that the probability of recession is low.

There are so many indications of the bear market in unprofitable companies. More than 80% of tech IPOs since March 2020 are below their listing price. Its because these companies don't earn anything and don't generate cash:

Stick with cash-generative companies - its boring but it works.

Yesterday we published some interesting charts. Target just cut its outlook for the second time in weeks, and the stock is down a further -7.5% in premarket trading, with WMT down -4% in response. Target is an example of a classic valuation compression market: TGT reiterated annual revenue growth of low-to-mid-single digits, and TGT said they expect to maintain or gain market share. Target also said that the consumer was resilient but they cut their current quarter operating margin forecast by 300 basis points, which is huge in a low margin business.