The Week Behind

Last week was painful. Depending on the index, it was either the worst week since COVID or the Great Financial Crisis of 2008. Unique dynamics were at play each session. A lot of information to digest, but let’s focus on the following:

• The Big-Tech Recap: GOOG, MSFT, FB, AMZN, APPL.
• Role of Earnings in a Down Market.
• PCE Report.

The Big-Tech Recap

Overall, I think big tech earnings came in stronger than expected. 

• The best was MSFT: strong topline and bottomline, good guidance, and enduring strength cloud and enterprise.
• Second place is FB: while topline missed, profit came in above consensus, DAUs grew, and Reels showed real progress. Last word on Reels, Mark said the short-form video platform is being under-monetized, suggesting there is still room for improvement. Following the print, FB experienced its best open in history, rebounding from ~$170 at ~13x earnings to ~$200 at ~15x earnings (PE).
• Third comes APPL: beat on both revenue and earnings; however, guided down $4-8 billion due to shutdowns in China. As a result, analysts adjusted their models, cut APPL’s price target, and APPL shares sold-off. The guidance assumes China reopens in June or July. If China reopens ahead of that deadline, expect a flurry of buying as that development sets up AAPL to revise guidance upward. 
• Fourth comes GOOG: this quarter was a little light due to Youtube’s performance in Russia and the Ukraine. That aside, GOOG has a strong quarter and remains cheaply valued with a PE of 20. GOOG is also a sleeper reopen play as most “experience” purchases (travel, shows, etc…) start with a Google Search. 
• Finally, AMZN: this was a bad quarter. Perhaps the market over-penalized AMZN, chopping 15% of the market cap, but the CEO admitted to over-expanding their retail division. Their demand projections for post-COVID were simply too high. Consequently, Amazon has overbuilt and overhired. The next logical step is layoffs, which could add fuel to the unionization effort that represents another headwind. 

Role of Earnings in a Down Market

Liz Young, investment strategist at SoFi, put it best. To paraphrase, she believes this market has a multiples problem, not an earnings problem. Earnings remain strong. Earnings are not what brought the market into a downtrend. Consequently, earnings are not going to be what gets us out. In markets like these, earnings set the floor when big flushes occur. Earnings are the difference between a 10% correction and a 30% correction, not what will propel us to new highs.

One way to assign price targets to a stock is take the stock’s EPS and apply a PE multiple. Liz is pointing out that the EPS (earnings) is not to blame for the downtrend, but the PE multiple is. Historically, the PE on the S&P 500 is inversely related to the 10-year treasury yield. You’ve probably heard fair-value on the S&P is ~18x earnings (PE). That is true when the 10-year is sub 3%. Between 3-4%, the S&P 500’s PE is between 15-18x. If yields remain elevated as many think they will, PEs will compress, decreasing stock prices unless companies can expand their earnings to offset that compression.

PCE Report

March headline PCE was 6.6%, up 0.9% from February, which is up greater than the 0.5% increase we saw from January to February. Core PCE, the FED’s favorite, was 5.2%, which was lower than consensus for March and lower than February’s core reading. From a core perspective, which ignores food and energy, there is some confirmation inflation has peaked. However, when you account for the costs that consumers cannot meaningfully delay or limit – food and energy – the heat is still on. 

The Week Ahead

This week’s setup is similar to the last time the FED hiked in March. Big tech had just reported, sentiment was bearish, and equities were rivaling their lows. We started the week down. The FED hiked 25bps. All indices rallied. It feels like we’re back in March. All that’s left is for the FED to hike. 

The FED meets on Tuesday and Wednesday to make the next hike official. While some people believe a 75bps hike is likely, given the negative GDP reading for the first quarter and a PCE number that suggests core is flattening, I think they go 50bps. 

Regardless of what the FED does, what’s more important is the direction of the market. At pivotal moments like this, I lean toward respecting the emotion in the market over the fundamentals of the companies in it. The head-and-shoulders inverse pattern is broken, and all major indices are in no-man’s-land below their major moving averages. In short, the market is more technically driven than fundamentally driven. 

If we see a couple strong closes after the hike and into the weekend, then we can start looking for confirmation that the current downtrend is running out of steam. However, if we continue the sell-off, then we need to look for signs of capitulation. The two tell-tale signs I hear most often are the VIX breaking 40 and the NYSE declining-advancing hitting 90-10. We check those boxes and a number of analysts who have refused to call a tradeable bottom will become a lot more constructive. If those events happen, it won’t be painless, but, historically, buying in that environment has been rewarded.