'The World According to GARP'
Might stocks offering 'growth at reasonable prices' provide refuge?
Garp was a fellow played by Robin Williams, not an equity investment strategy. But there are similarities. The 1978 novel and subsequent film was all about the ambiguities that characterize modern life. Ambiguities characterize today’s market. It’s been stuck between good economic news on some days (more below), not so good on others (more below). Markets are waiting for something to break. Don’t look to consumers. They continue to surprise. Spending on goods, while slowing, is running 4.4% above its pre-pandemic trend. Restaurants and hotels are booked. So are airlines. Air traffic has soared above 2019 levels. AAA is projecting the third-biggest Memorial Day travel weekend since 2000. When you put $9 trillion in Americans’ pockets, they’re going to yuck it up. It takes time to work through all the Covid largesse—Empirical Research projects the excess savings stockpile won’t be depleted until mid-2024. A tight job market continues to put money in pockets. Initial claims are still pointing to limited layoffs and stickier unemployment, while slowly moderating inflation is providing price relief. In fact, real incomes are now rising, and the appetite for borrowing on autos, credit cards and other non-mortgage categories is growing despite stingier banks. Weakness has been in such high-paying industries as tech and finance, where openings have fallen 20-30% and wage growth plunged from +9% a year ago to around +3.7%. At 4% of all workers, those industries aren’t large enough to “crash the bus,” as Empirical Research puts it. But the softness does suggest slower hiring and wage growth. Still, the Fed is unlikely to get its desired 4.6% unemployment rate by year-end.
Of course, things can look OK, until they aren’t. At some point, the piper has to be paid. The tension between positive economic momentum (nonfarm payrolls) vs. cracks (manufacturing, housing, banks) leaves the economy vulnerable to shocks. Strategas Research offers the debt ceiling and CRE as possibilities. There are signs of deterioration in credit markets, where all-in financing costs keep rising, lending standards are tightening, demand is plunging and YTD bankruptcy filings are the highest since 2010. There hasn’t been a proper credit cycle (big increases in corporate defaults, consumer delinquencies and bankruptcies) since the global financial crisis. Though the market wants a Fed pivot, history says stocks tend to do better when the Fed pauses, less so when it starts to cut. For now, we’re trapped in a zone. Global equity indexes are near YTD highs even as household inflation expectations are rising and central banks are threatening more hikes. This against a backdrop of a top-heavy market that has seen just five mega-caps drive 70% of the S&P 500’s return since October, one of the narrowest 6-month periods of the last century. The only way investors have made real money since fall has been through FAANGS + Microsoft.
Does this lack of participation matter? Empirical’s research shows market breadth has little if any relationship with subsequent returns. And Renaissance Macro notes there also have been gains among home builders, health-care services and smaller software names. A maturing broad-based advance may be of concern when it narrows, but Oppenheimer says it’s broad-based selling that’s on the decline. That’s bullish. With profitable growth stocks a winning strategy since Feb. 2, Piper Sandler wonders when it will be time to get more defensive? The “rolling recession” thesis overlooks that every previous recession started out by “rolling,” the lone exception being the Covid exogenous-shock downturn of 2020. At the high end of the 7-month range, the S&P is expensive and trading at a historical premium to every asset class except 10-year Treasury bonds. This suggests security and sector selection may provide better opportunities than index investing in the months ahead. Growth at a reasonable price. The market according to GARP.
- The consumer continues to surprise April retail sales disappointed at the headline but at the core level rose 0.7%, well above expectations. Gains were driven by a few large categories: non-store retailers, general merchandise, and restaurants & bars. Health & personal care also continued to report robust growth, the only component to register increases every month this year. Furniture, electronics & appliances, and clothing softened again.
- Is manufacturing rebounding? Factory production jumped 1% in April, doubling consensus, as motor vehicle and parts production surged. The 1.4 million increase in auto assemblies rose to the highest level since February 2020. The output helped lift overall industrial production by 0.5% on the month vs. expectations for no gain. Early reads on May regionals were mixed, with the Philly Fed index surprising to the upside while the Empire index disappointed.
- Earnings surprise Though Q1 earnings were down 2.2% y/y, they handsomely beat expectations. Interestingly, analysts haven’t adjusted rest-of-year or next-year earnings expectations
- Housing fights headwinds April housing starts rose while permits fell as housing’s attempt to exit recession could fail if tightening lending standards take hold. Buyers continue to face a dearth of choices, a key reason April existing home sales declined again. Builders are working as fast as they can—single-family construction is driving activity, and NAHB sentiment jumped in May to breakeven, with present sales their highest since August and sales expectations their highest since June.
- Recession on the horizon Conference Board leading indicators fell a 13th straight month in April. Eight of the 10 components were negative, with only stock prices and manufacturers’ new orders for both capital and consumer goods improving. The Conference Board says its data suggests the economy will begin to contract this quarter and into Q3.
- Overseas weakness China’s growth momentum from its January reopening weakened significantly in April, raising questions about the potential for a stimulus package. The most worrying data was property sales, which plunged to 63% of the 2019 level from 95% in March. In Germany, the contraction in widely watched ZEW expectations deepened on rate hike and U.S. debt-ceiling worries.
Don’t confuse a debt-ceiling deal with “All Clear!” At this writing, they halted debt-ceiling talks, casting a cloud over hopes for a positive resolution. But history suggests what happens afterward may be worse. A deal could bring an end to liquidity injections ahead of the X-date, and likely will include a pullback in fiscal spending. In 2011, nearly all of the S&P’s decline happened after the debt-ceiling deal was struck. And in 2021, the S&P rolled over the day the debt ceiling bill was signed as it ended the liquidity injections.
This is what range-bound looks like Gavekal Research shares that since the end of Q1, the S&P’s closing Friday level has successively stood at 4,131, 4,136, 4,169, 4,133, 4,137, 4,105 and 4,109 for a range of 1.6%! Meanwhile, 10-year Treasuries traded at 3.48% at the start of the quarter, 3.39% a week later, then 3.52%, 3.57%, 3.44%, 3.44% and closed last week at 3.46%. U.S. corporate bonds have been just as dull.
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