AM Brew, May 10th 2022
After an un-surprising bloody Monday, with indices down a sharp -3% yesterday, futures are trading up approximately 1% as of 10:30 am in London. Stepping back and looking at the big picture, we find nothing too surprising and it can be argued that markets are following a time tested script: the Fed prints money leading to a boom in stock, bond and real estate markets. Boom leads to bubble in the aggressive sectors, well telegraphed supply disruptions and the money printing and markets euphoria lead to higher prices.
Lack of capacity addition in fossil fuels plus an unexpected Ukrainian shock leads to runaway inflation led by higher energy prices. The Fed responds with tightening, spurring a mini-bear but a massive bubble pop in the tech story stocks.
In hindsight, this narrative followed a pretty time tested script. The scary Monday following a scary Friday is a well known pattern - no surprises there. The Tuesday London futures bounce is also following a time-tested script. So, what follows? With respect to tech stocks, the historical script tells us that we are in the 8th inning of the selloff in quality names. Bloomberg had a nice chart showing the P/E round trip roller-coaster on the Nasdaq 100 stocks:
For solid tech companies with earnings, P/E multiples in the low 20s make sense even in the higher rate environment. The script tells us that the bear market in the profitable big tech names is in the 8th or 9th inning. Be sure to differentiate between profitable tech and non-profitable tech. Apple, Google and Microsoft are near the bottom but a company like NFLX that doesn't throw off cash is something to be avoided.
The script generally calls for a weak economy due to inflation & higher interest rates. We are already seeing that now and expect the economy to be weak for another 6 months. Economic weakness combined with higher energy prices is not good for cyclical names. You won't want to buy a gas-guzzler at these gasoline prices, and with fuel being 40% of an airlines costs at these levels, cyclical stocks like airlines and cruise ships are to be avoided. Now is the time to start following your cyclical names: if you get a washout in a historically quality company, you want to be prepared to buy later in the year. For example, Carnival (CCL) was free cash generative prior to 2020, and it should be able to return to its former status. Buying cyclical stocks coming out of a downturn can provide returns of 3X and 4X for those that can hold on for the ride. With $30 billion in debt, CCL doesn't excite me as an investment but that debt makes the stock option like both on the upside and downside. We advise to do your homework now, keep a list of cyclicals with entry target prices. For example, if CCL trades below $5, we would want to take a long position viewing it as an option-like position. The long term chart of CCL is showing the company trading at near cyclical lows:
But charting only takes a longer-term investor so far - CCL's debt exploded in the pandemic, and now the stock is more option like, especially in a rising rate environment:
CCL's debt was pretty consistent for years around $7 billion but now it has bloated to $30 billion - that $23 billion difference makes the equity worth $20 per share less than before. So, in three prior cycles, you had CCL spike up to $50 and higher, but now your upper target is $30 due to the debt robbing equity by being senior in the capital stack. Do your own research, but CCL is the type of cyclical name that could be put on the radar screen for potential purchase at $5 or below. If you agree with the "script is playing out thesis" then you want to be watching the cyclicals now because they are likely to be the market leaders when the Fed eases and the economy rebounds.
Eurodollars appear to be playing out according to the historical pattern. We got long a contract but internal debate was strong with Petr arguing for a large long position in Eurodollars. Looking at the long term DeMark chart of Eurodollars, we see that its trading near the bottom of pre-pandemic channels, and that any good news from the Fed would spur a violent upward spike. The DeMark chart also recently indicated a buy signal a few weeks back, but the December 2023 Eurodollar contract (ticker: GE on Globex) still looks like an interesting long here:
As always, plenty of economic news coming: CPI & EAI Crude Inventories Wednesday, PPI & Jobless Claims Thursday. Don't over-weight any comments this week from the 3 Fed governors scheduled to speak: Loretta Mester, Raphael Bostic, John Williams, Christopher Waller, and Mary Daly - the script is usually the majority toes the party line with "approved dissenters" speaking out to the press, further adding uncertainty to your process. More interesting to us are recent comments by Saudi and UAE oil ministers that they have never seen capacity so tight.
Dr. Copper has been weak and our systems make us a bit bullish on Freeport, but the historical script generally says commodity trends stay in place for a while. The 5 year copper chart shows three years of a range trade, then a year-long bullish up move, and the current move seems to short in duration - copper has traded within a channel for a year but it appears that the economy is weakening & Dr. Copper is breaking through the bottom of the channel:
Evidently Cathie Wood's returns are now below the S&P500. Again, playing to the script: its easy to make big money on a small capital base but harder at the top. This is significant because Ark has not seen large redemptions yet, and large redemptions by Ark would be a feeding frenzy on Wall Street - letting it implode and then scraping up the carcass on the cheap. Be extra careful getting long any of Cathie's names as individual investors have not redeemed yet, and history suggests that they will.
The last half-hour today could potentially provide us further data on the market's tone. If the market ends the day negative, these strong futures prices in London are just a technical breather and a lower close almost certainly indicates further downside to $3,850 on the S&P500. Contact us for further in-depth analysis on DeMark Technicals, Individual Company Fundamental Analysis or our Economic Outlook.