Markets Fight The Fed

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Late last week, the US Federal Reserve raised interest rates by another .25%. This was largely expected. More significant were Powell's comments in terms of how the Fed sees the fight against inflation. Here are the highlights of Powell's speech, paraphrased:

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• We are not yet in a restrictive range
• We are in the early stages of the process
• We expect housing inflation to continue
• We have not yet seen evidence that non-housing services pricing has changed
• Ongoing rate hikes are necessary
• There is still work to do
• The job is not done
• For 56% of the economy, we have not seen any change to inflation. All the deflation has happened to less than half of the economy
• We will update the terminate rate target in March
• Core goods inflation is still at 4%
• Supply chain issues have been largely resolved
• COVID is no longer an economic threat
• We are not likely to cut rates this year

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Right, so what this means is the Fed is going to hold rates higher for longer than the market thinks. Powell also stated that there is more risk to not doing enough than there is to overtightening because they have the tools to unwind the overtightening while the opposite is harder to do given the stickiness of inflation.

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Right now, traders are celebrating a win that Powell and the Fed recognize that there has been deflation and that they are looking at the data. They are holding the belief the Fed will pause or cut rates this year before doing too much damage to the economy. This narrative is likely to shift later in the year when the Fed holds its ground, upsetting the expectation.

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Friday, the Fed received more ammo to hold rates higher for longer by an absolute blockbuster of a jobs report which showed 276% more jobs were created in January than anticipated. The increase brought the unemployment rate to the lowest in 53 years.

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The strong jobs data supports the case for Powell to hold rates higher for longer, which can bring earnings growth down as companies see lower demand and higher costs for capital needed for expansion.

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Historically, the Fed has been successful at engineering a soft landing only once after raising rates this quickly. In most cases, it ends in recession and a market selloff.

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Bears Get Tranqed

The overall sense in the market was that the bulls were in control and had put the bears in their corner for now.  The big bears like Michael Burry and Mike Wilson continue to issue warnings to sell this rally but their pleas were ignored.  

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The top performing sectors last week were Communications Services and Technology - the biggest losers of 2022.

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The appetite for risk is higher, as seen from the rise in prices for speculative assets like Bitcoin and growth tech stocks.  And the safety plays that did well last year - utilities and healthcare - performed the worst last week.

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All this happened while the earnings lowered for S&P 500 companies, as shown in the chart above. We'll go into this in more detail in our Level 2 newsletter.

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Revenge Trading

Remember the "revenge travel" reaction following mass COVID vaccinations? There has been so much fear in the market and cash parked on the sidelines that it feels like there's a lot of revenge trading going on. The party began to fade Friday, however, as the reality of a steadfast Fed and a declining environment for earnings growth set in following disappointing earnings reports from Apple, Amazon, and Google.

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KNOWLEDGE CORNER: WHY (DIVIDEND) SIZE MATTERS

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It is difficult to know how companies are performing and what company leaders anticipate for the companies they run. The CEOs have to put on a good face when speaking about the companies they represent. And their communications team makes sure of that. So how can we determine whether a company will perform well in the future?

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Dividends are one way. A company giving away its money to shareholders is typically a company with stable enough revenue in the present and forecasted future to enable it to provide capital back to its owners. If the leadership thought the company was about to take a huge hit to profits, they would not be increasing the dividend.

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The bigger the dividend increase, the more confident leadership is in its cash flow situation. However, the size of the dividend before the increase matters.

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A company increasing its dividend by 100% from 1 penny a share to 2 pennies a share doesn't make much difference to an investor. But a company with a $4.00 dividend increasing it 25% means an extra dollar per share per year for every shareholder. For a holder of 1,000 shares, that's $1,000 more a year for doing nothing but holding the stock.

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In the dividend increase scenario, the biggest share price movements follow the biggest increases in the dividend amount. And over the longer term, these companies raising dividends by large amounts tend to perform well. A look back at energy companies in 2021 and 2022 can easily show these patterns.

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For example, ConocoPhillips (pictured above) increased its dividend in October 2020 - right as the price of oil had recovered from epic price falls and the energy sector was about to go on to have a huge bull run. Notice the event impact on the day of the announcement was not positive due to other macro events of the day, but the follow-on price action over the subsequent years was spectacular.  

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HIGHLIGHTS FROM LAST WEEK

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Dominion Dominates

Old Dominion Freight (ODFL) posted record revenue and profit for the fourth quarter of 2022, then increased their dividend by 33%. The rail company's stock price rocketed ahead +10.5% on the news.

Smoking Hot

Nicotine peddler Altria Group (MO) notched a 6% gain after announcing plans for a $1B buyback. They projected earnings growth of 3-6% per share in 2023.

FedEx Trims The Fat

FedEx stock jumped over 4% after announcing they would be laying off 10% of their management staff in an effort to cut costs amidst cooling demand. The company is aiming to cut about $3.7 billion in total during this fiscal year, which its CEO has forecasted to be "bumpy."

EV Wars

Shares of Electric Vehicle maker Rivian rose 6% after announcing its intention to layoff 6% of its workforce as it tries to save the cash it has been rapidly burning through.  Rivian has been plagued by supply chain issues and production problems since its monster IPO which resulted in some of the worst losses in the market for those who chased the IPO price to 130 (it currently trades at $19/share).

Rising car loan costs, increased competition for EV sales and recent cost cuts by Tesla and Ford mean Rivian is going to have a tougher time selling its vehicles. Really the only thing keeping the share price up this high is its contract with Amazon to supply EV delivery vans.

METAmorphosis

Shares of the company formerly called Facebook soared over +23% on news Zuck and his board authorized the repurchase of $40 billion of META stock. META also announced earnings results, which missed estimates but showed more stable demand for advertising.

META is up 100% from its 52-week low now, and the narrative has shifted among pundits that the company is back to reality, being focused more on profits than the Metaverse dream.

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Key Earnings Announcements This Week

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February 6

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Notable Earnings:

• Chegg (CHGG)
• Activision Blizzard  (ATVI)
• Tyson Foods (TSN)
• ON Semiconductor (ON)

February 7

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Chipotle Mexican Grill (CMG)

• With Chipotle's earnings on Tuesday, investors will be looking for guidance on spikes in production costs and comments on their recent push to increase hiring.

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Other Notable Earnings:

• BP (BP)
• Assurant (AIZ)
• Essex Property (ESS)
• Illumina (ILMN)
• Enphase Energy (ENPH)
• Western Union (WU)

February 8

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Disney (DIS)

• In the last quarter, the entertainment giant has stayed in the headlines. After ousting their CEO Bob Chapek and replacing him with Bob Iger, a big Q4 miss, and mass layoffs in November, investors are waiting for guidance on theme parks post-China reopening and with an increase in travel. Comments on Disney+ subscriber growth are also a major focus due to Netflix's recent positive performance.
• It is also worth noting that Nancy Pelosi sold 10K shares of Disney at the end of December.

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Other Notable Earnings:

• Affirm (AFRM)
• CME Group (CME)
• CVS Health (CVS)
• Dominion Energy (D)
• MGM Resorts (MGM)
• O'Reilly Automotive (ORLY)

February 9

• Paypal (PYPL)
• Events surrounding Paypal in the last few months include mass layoffs to cutting costs, headwinds facing the e-commerce space, and drama over an announcement of a policy that would fine users $2500 who spread misinformation.

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Other Notable Earnings:

• AbbVie (ABBV)
• AstraZeneca (AZN)
• Cloudflare (NET)
• Duke Energy (DUK)
• Hilton (HLT)
• Kellogg (KG)
• Lyft (LYFT)

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February 10

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Notable Earnings:

• Spectrum Brands (SPB)
• IQVIA (IQV)
• Enbridge (ENB)

Economic Reports:

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2/7  

• International Trade Deficit

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2/9

• Initial Jobless Claims

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2/10

• Federal Budget Balance

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The LevelFields Team