What’s the really Fed going to do this year? When will this non-stop speculation end?
According to the WSJ, investors in interest rate futures expect the Fed to raise rates by +25 bps two more times — once in the upcoming meeting at the end of the month, and again in the March meeting.
In December, most Fed officials projected a peak rate of 5%-5.25% — implying raises of +25 bps in at least the next three meetings.
There’s also a stark contrast surrounding when the actual pivot will take place. Over the past few months, The Fed seemed to all-but-guarantee that rate cuts wouldn’t happen this year. Now, many are calling that a bluff and foresee rate cuts by as soon as this summer.
Translation: Investors believe recent government data and business surveys reasonably justify the Fed will pump the brakes in 2023.
So when the rates go down, things will inevitably go up and to the right?
Well, not really.
In the chart below, the green lines show notable times in which the effective Fed Funds rate started to come down (actual pivot). Each of those times led to fresh, near-term market lows:
It’s also worth noting that the current Shiller PE ratio is ~29.
The Shiller P/E Ratio is a valuation measure that uses inflation-adjusted earnings per share over a 10-year period to smooth out fluctuations in corporate profits.
Also known as the Price Per Earnings ratio, CAPE Ratio, CAPE, or P/E 10 Ratio.
The average Shiller PE Ratio of the S&P 500 since 1870 is ~17. The median is ~16.
That’s not to say that “everything is overvalued.” Rather — it means this would be one of the “most expensive” starts we’ve ever seen if in fact we’re now back in a bull market. Food for thought.
Worth Noting — the Conference Board’s Leading Economic Indicators (LEI)
See below for a note from Jaguar Analytics, with whom I’ve co-led some Twitter Spaces recently.
“We started to point out a sharp deterioration in leading economic indicators “rate of change” in summer 2021 and since then we’ve been bearish. 18 months later it still hasn’t improved.
Never in history since 1960, has this indicator posted 6+ consecutive months of m/m decline without the US going into a recession. The last reading marked 9 consecutive monthly decline as shown in chart above.
The GDP deterioration will eventually follow with a lag and currently it is pointing to -2% or worse in coming months, which remains our base case scenario for 1H23. Whether it be a hard or a soft landing will depend on labor market, but there will be a landing of some sort.
The bottom line is that my favorite indicator is giving me a red hot flashing warning which keeps me on sidelines — while everyone is fixated on breakout through 200-day moving average.”
Our General Thesis:
It’s important to remember that the market is very forward-looking.
The graphic above is grossly over-simplified, but the key reason for its inclusion is to highlight that the economy and the stock market rarely trend in perfect tandem.
The stock market has never bottomed with the 10YR / 2YR U.S. Treasury spread being inverted. The market also rarely bottoms before a recession starts. However, we could already be in a (very unique) recession right now — and solely relying on historical trends never leads to the best results.
We believe new lows are ahead, but we aren’t sure when they will arrive.
What does that mean for you? If your plan is to invest into broad market index funds — then it’s reasonable to continue dollar cost averaging throughout 2023. However, I’d encourage you to learn more about beaten down high-quality tech (think Snowflake, Datadog, etc.)
If you are following along with my Portfolio Updates (below) and want to make your money work for you in specific, strategic ways — then it’s reasonable to begin deploying a smaller, more responsible amount of money as we continue to see strength in the markets.
Once things begin to flip more bearish — get more aggressive.
The base case of investors has shifted from a recession to a period of disinflation and below-trend growth (AKA “soft landing”). The danger in the markets right now is that the picture has become much rosier, much quicker than most would have expected.
As always, we’ll be here to update you every step of the way. If you know someone who would also appreciate these updates — consider sharing Rate of Return with them (below).
First, I want to thank the 125 of you who have signed up for Quantbase, and the 66 of you who are investing alongside me in my Dividend Growth strategy — the strategy’s fund just surpassed $110K in assets under management! 🎉
You all have invested over $300K in assets across Quantbase’s different funds — it’s so cool to see you all finding a strategy that suits you and getting after it. For transparency, I’m also investing $100 / month toward their Crisis Flagship fund.
If you want to join the other 100+ folks in our community who are investing either toward my Dividend Growth strategy or other Quantbase funds — read this recent post I shared that breaks it all down.
I’ve attached updated screenshots in the Portfolio Tracker (paying subscribers-only) for you all to review — no material changes this week.
Important Quant Rating Changes:
Salesforce (CRM): 4.70 to 3.42 — this might have something to do with the recent “downgrade” the stock got from an analyst of Wall Street, citing uneven growth in 2023 and 2024.
American Tower Corporation (AMT): 4.78 to 3.33 — we called the original “Hold” to “Strong Buy” in this post, and it seems the rating was short-lived. With that being said, I highly recommend watching this 60-second video about the company.
Balance: $20,117
Week in Review — Too Long, Didn’t Read:
Netflix is forecasting $3B in FCF throughout 2023, Ally Financial is forecasting -$460M in net charge-offs on their retail auto loans, Proctor & Gamble experience a -6% decline in sales volume, the Corporate Bond market is flashing a warning sign, the U.S. Debt Ceiling has been reached, Janet Yellen seems to be buying up bonds, Retail Sales dropped considerably, the Producer Price Index follows suit with inflation being tamed, and the Housing Market Index rose for the first time in over a year.
Key Earnings Announcements:
Netflix is forecasting $3B in FCF during 2023, Ally Financial is forecasting -$460M in net charge-offs on their retail auto loans, and Proctor & Gamble experienced a -6% decline in volume.
Netflix (NFLX)
Key Metrics
Revenue: $7.9 billion, an increase of +2% YoY
Operating Income: $550.0 million, compared to $632.0 million last year
Profits: $55.0 million, compared to $607.0 million last year
Earnings Release Callout
“For 2022, we finished with 231M paid memberships and generated $32B of revenue, $5.6B in operating income, $2.0B of net cash from operating activities and $1.6B of free cash flow (FCF). In 2023, we expect at least $3B of FCF, assuming no material swings in F/X.”
My Takeaway
Much of their Letter to Shareholders was outlining their next few quarters of growth — as well as how they plan to get there.
Here’s the roadmap: revenue, not total number of subscribers, is the new benchmark — they believe as ads and other initiatives drive top-line growth, this line item will become increasingly more important to watch.
1Q23 revenue growth should come in around +4%, driven higher by added subscribers. However, they did warn that as paid ads begin to rollout worldwide they expect folks to cancel their subscriptions — negatively impacting subscriber count. Finally, they outlined an 18-20% operating margin during 2023 — which equates to ~$6.5B in operating income (about +$1B more than 2022).
More importantly, this statement was included in Netflix’s Letter to Shareholders — ”Now that we are a decade into our original programming initiative and have successfully scaled it, we are past the most cash intensive phase of this buildout. As a result, we believe we will now be generating sustained, positive annual free cash flow going forward. Assuming no material swings in F/X, we expect at least $3B of FCF for the full year 2023.”
Here are my thoughts — even if the company delivers on this $3B in FCF.. heck even $4B in FCF during 2023, they’re still trading at 45X price to FCF. No company growing top-line revenue by mid-single digits, experimenting with a new product rollout, and heading into a recession (where more people are likely to be stingy with their subscriptions) should be trading at 45X price to FCF.
I’m not an investor at the current $350 / share price. The stock could rally higher in the near-term, but I think Netflix’s stock is over-valued and should trade back down to the $250 / share range. No position.
Ally Financial (ALLY)
Key Metrics
Revenue: $2.2 billion, an increase of +10% YoY
Profits: $278.0 million, compared to $299.0 million last year
Earnings Release Callout
“In 2022 Ally continued its strategic evolution while navigating a fluid macroeconomic environment. We’re continually assessing the macroeconomic backdrop and remain nimble operators.
Our heightened focus on investment across the enterprise ensures every dollar is aligned with our long-term priorities while our dynamic underwriting across all asset classes allows us to pivot as needed ensuring we maximize risk-adjusted returns and remain well positioned for a variety of environments.”
My Takeaway
As you all might remember from last week’s Week in Review, I’m not the type to hyper-analyze bank stocks — just not something I’m very good at. Instead, I like to dive deeper into their unique perspectives on the current state of the economy — considering all of their first-party data.
I think the slide below paints the picture very well —
Ally Financial, like the other banks we covered last week, is experiencing heightening delinquencies and net charge-offs (bad debt from their consumers). All of the graphs above depict net charge-offs and delinquency rates higher than Q4 of 2019 — before the pandemic took place.
Ally Financial has stashed away $3.7B in reserves to ensure their business will be able to continue operations in case customers stop paying back their loans — this $3.7B figure increased +$400M during 2022 alone.
Slide 25 of their presentation forecasts retail auto net charge-offs to increase from 1.66% in Q4 2022 to 2.2% in Q4 2023 — as well as a mild recession.
Hold on to your hats — 2023 is going to be a bumpy ride. No position.
Procter & Gamble (PG)
Key Metrics
Revenue: $20.8 billion, compared to $21.0 billion last year
Operating Income: $4.9 billion, compared to $5.2 billion last year
Profits: $4.0 billion, compared to $4.2 billion last year
