For a PDF version of the below commentary please click here Weekly Letter 5-23-2022

Callahan Capital Management

Weekly Commentary | May 23rd, 2022

 

Major Theme of the Markets Last Week: Markets Moved Lower in a Wild Ride

U.S. equity markets once again had a roller coaster of a ride last week with some well-known large companies experiencing gains of more than ten percent early during the week, only to see investors reverse their buying toward the end of the week and close down by more than ten percent. Markets started last week with the technology heavy NASDAQ under pressure with Tesla falling nearly six percent after uncertainty arose over CEO Elon Musk’s potential buyout of Twitter over the weekend. Markets ripped higher on Tuesday with most of the equity indexes in the U.S. gaining between two and three percent for the day in one of the larger moves we have seen so far this year. Some of the gain experienced on Tuesday was due to Fed Chair Powell commenting to The Wall Street Journal gathering that the Fed was still not considering a 0.75 rate hike at the next meeting while reiterating that a 50-basis point hike was still the most likely outcome of the meeting. Chair Powell also continued to be clear that fighting inflation while not hurting the labor market was the goal of the Fed moving forward. These comments were followed by more comments from the Fed chair on Wednesday that put pressure on the equity markets.

 

On Wednesday, Target released its earnings before the markets opened and, much like Walmart the prior day, they were not positive, sending Target stock down nearly 25 percent in the day, the worst trading day for the stock in the history of being listed. On top of poor earnings from major retailers, investors also contended with Chair Powell once again making comments, only on Wednesday he sounded more hawkish than on Tuesday. Chair Powell said that fighting inflation was an “unconditional need” and the Fed would be raising rates as much as necessary, even if it causes some short-term pain to get inflation under control. While the Fed has repeatedly said it does not watch the U.S. financial markets or make any decisions based on market levels, it sure was curious that when it appeared the markets were thinking Chair Powell was being less hawkish and reacted as such, the following day he made hawkish comments, which sent the markets lower. The comment ultimately led to a large indiscriminate decline in the equity markets on Wednesday with the Dow falling more than 1,100 points while the NASDAQ declined by 4.7 percent.

 

Markets settled down on Thursday and Friday, trading in relatively narrow trading ranges on both days, ultimately ending the week with declines of between one and nearly four percent for the week. The declines for the week were broad with there being very few safety spots for investors to hide, as even historically safe areas of the markets such as Consumer Staples and Utilities experienced declines. On Friday, the S&P briefly dipped below a 20 percent decline from the peak experienced back in November of 2021. Officially, the decline was 20.9 percent, which would signal a bear market for the index. However, the decline was quickly bought, and the S&P did not close below the 20 percent decline level. While there is some debate about whether the S&P has triggered a bear market, historically it has been closing levels that are used to determine a decline of 20 percent or not. On an intraday basis, we technically hit a decline of 20 percent or more and a bear market, though most technicians would say that the S&P has still not broken down into a bear market. When one looks at it, however, the fact remains that the markets have declined significantly and at least currently it looks like there will be some very good buying opportunities in the near future in many different areas of the markets.

 

Financial News Impacting the Markets

 

Earnings were the other major finance news of the week last week, with big box retailers being the focal point for the markets and the results were mixed. The table below shows some of the better-known companies that reported their earnings last week with companies that beat earnings expectations by more than ten percent highlighted in green, while those that missed expectations are highlighted in red:

 

Applied Materials -2% Home Depot 11% The TJX Companies 13%
Cisco Systems 1% Lowe’s Companies 8% Walmart -11%
Deere & Company 2% Target -27%

 

Labor costs, fuel costs, supply chain issues and a slowing down and changing U.S. consumer hurt some retailers last week, notably Walmart and Target, while helping other such as TJX. Home Depot and Lowes, typically frequented by people who have the disposable income for home projects, didn’t feel the hit as much as spending continued to be strong in a warmer than usual end of Spring and start of Summer around many parts of the U.S.

 

According to FactSet Research, we have seen 95 percent of the S&P 500 report earnings for the first quarter of 2022. Of the 475 companies that have reported, 77 percent have beaten earnings expectations, 3 percent have met expectations and 20 percent have fallen short of expectations (these numbers are unchanged from last week). When looking at revenue expectations, 73 percent of the companies that have reported have either beaten or met expectations while 27 percent have fallen short. The overall blended earnings growth rate for the S&P 500 for Q1 2022 is currently 9.1 percent. While 9.1 percent may seem like a high number, it is actually the lowest quarter growth rate for the S&P 500 since the fourth quarter of 2020. Forward looking guidance given by companies that have reported has also been pretty weak with 70 percent of the guidance being negative. At this point in the earnings season, it mathematically becomes very difficult for any of the above numbers to change by a material amount as there are just 25 more companies out of 500 that need to report, and they are almost all very small components of the S&P 500. While earnings season for the first quarter of 2022 was good, it was weaker than previous quarters, yet stronger than expected and showed signs of concerns moving forward. Moving forward, we don’t have the same easy year-over-year comparisons and all companies are having to contend with inflation that is the highest that we have seen here in the U.S. since the late 1970s or early 1980s.

 

China made headlines last week as the People’s Bank of China unexpectedly cut interest rates to help the country combat the impacts of the COVID-19 lockdowns. The rate cut most directly impacts the Chinese housing market which saw home sales decline a meaningful amount during the month of April. In Beijing, some areas of the city have continued to come out of COVID-19 lockdown while others remain in lockdown and yet others have just started lockdowns. The country appears to be struggling to contain the virus while at the same time acknowledging that it has to keep its economy running and can’t afford to have everything shutdown for an extended period of time.

 

In Europe last week, the economic data flowed in the U.S. with inflation being shown as increasing while consumer confidence and spending appear to be faltering a little. The European economic commission cut its growth rate for the region last week, citing inflation as well as the war in Ukraine and the negative impact it is having on the region. There were few developments in Ukraine over the past week as the fight continues in the eastern parts of Ukraine. At this point, it does not look like this will be a “winnable war” and that the two sides will likely remain in conflict for an extended period of time. This will likely keep energy prices, oil and gas specifically, elevated until there is some sort of conclusion to the war. Here in the U.S., we are already seeing the price of the war as gasoline prices continue to move higher with the average cost of a gallon of gas hitting $4.63 earlier today, according to AAA. Natural gas prices here in the U.S. have also increased but not on the scale in Europe.

 

Market Statistics

 

  • Equities: Major U.S. indexes posted losses last week, extending a weekly slide that has been in place for as much as eight weeks for the Dow, something that has not occurred since 1923, according to The Wall Street Journal. Volume last week pulled back from what we have seen over the past few weeks as it was just an average trading volume week. NASDAQ and large cap technology continue to be the area of most pain when looking at investments as they once again came under selling pressure last week.

 

  • Russell 2000 (-1.08%) – Average volume
  • Dow (-2.90%) – Average volume
  • S&P 500 (-3.05%) – Average volume
  • NASDAQ (-3.82%) – Average volume

 

  • Sector Performance: When looking at the sector performance for sectors that turned in the best performance last week, there was not a consistent theme in the winning sectors. Pharmaceuticals led the way higher but on some strong moves in relatively unknown companies. Infrastructure and materials go hand in hand many weeks and last week it was to the upside as the construction and rebuilding time of the year has arrived in many parts of the U.S. Biotechnology came in third last week and, much like Pharmaceuticals, there was not a clear trend for why the sector performed so well with a few smaller companies driving a large part of the overall gain. Rounding out the top performing sectors last week was the energy sector, which moved higher thanks in large part to U.S. and European based energy companies as they stand to benefit the most from Europe and the rest of the world moving off of Russian energy as quickly as possible.

 

When looking at the sectors that underperformed last week there were a few themes, with the first one being the U.S. consumer. On the back of the Walmart and Target earnings reports, Consumer Discretionary and Staples both moved lower on concerns of a slowing of consumer spending in the face of high inflation. Transportation made the bottom performing sectors list last week as the rail companies moved lower on higher costs as well as continued supply chain issues. The Technology sector last week was pulled down by poor performance in the cyber security sector and Tesla, which declined by more than 13 percent for the week. Multimedia Networking was drug down by Cisco falling more than 13 percent on a poor earnings report.

  • Top Sectors: Pharmaceuticals, Infrastructure, Biotechnology, Materials, Energy
  • Bottom Sectors: Multimedia Networking, Technology, Transportation, Consumer Staples, Consumer Discretionary

 

  • Commodities: Commodities were all positive last week, led by gains in metals. The Goldman Sachs Commodity Index (a production weighted index) advanced 1.03 percent for the week as Oil had a very muted week, advancing by only 0.46 percent, as there were no significant developments out of Europe, OEPC, the U.S. or Russia related to the oil markets. Metals were positive last week, breaking what would have been a five week slide with Gold, Silver and Copper gaining 1.92, 3.35 and 4.61 percent, respectively. Soft commodities were also positive last week with Livestock posting a gain of 3.78 percent for the week as Grains moved higher by 1.17 percent and Agriculture overall posted a gain of 0.27 percent.

 

  • GS Commodity Index (1.03%)
  • Oil (0.46%)
  • Livestock (3.78%)
  • Grains (1.17%)
  • Agriculture (0.27%)
  • Gold (1.92%)
  • Silver (3.35%)
  • Copper (4.61%)

 

  • International Performance: Global index performance was split last week with 53 percent of the global indexes moving higher, while 47 percent declined. The average return of the global indexes last week was 0.46 percent. When looking at the global index performances for the previous week, the best performing indexes were in Southeast Asia, eastern Europe and India. When looking for regions that struggled last week, the USA is at the top of the list as well as the Caribbean and Africa.

 

  • Best performance: Lebanon’s BLOM Stock Index (15.28%)
  • Worst performance: Saudi Arabia’s Tadawul All Share Index (-5.49%)
  • Average: (0.46%)

 

  • Volatility: While the VIX briefly moved over 30 last week during the large market decline on Wednesday, the spike quickly dissipated with the VIX posting a much smaller gain of only 1.94 percent for the week. For the week, the VIX closed at 29.43, which implies a move of 8.5 percent over the course of the next 30 days for the S&P 500. As always, the direction of the movement is unknown. The VIX does not seem to be signaling that the markets are going to be super volatile, but rather less volatile than we have been seeing the past few weeks. There was some chatter last week about the VIX being broken, due to investors finding other ways than options to hedge out their portfolio risks and that it is no longer a very strong gauge of market fear. While that may be the case, so far there isn’t anything that has been developed that takes the place of the VIX. So, for the time being, the VIX will continue to be one of the fear barometers for the markets.

 

Model Performance and Update

 

For the trading week ending on 5/20/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model -2.12% -12.70% 4.07%
Aggressive Benchmark -1.04% -15.93% 5.33%
Growth Model -1.78% -9.44% 3.71%
Growth Benchmark -0.79% -12.48% 4.45%
Moderate Model -1.44% -5.94% 3.34%
Moderate Benchmark -0.55% -8.96% 3.48%
Income Model -1.35% -4.25% 3.27%
Income Benchmark -0.27% -4.42% 2.14%
Quant Model 3.40% -15.63%
S&P 500 -3.05% -18.14% 9.69%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes to the hybrid models over the course of the past week. The performance of the hybrid models was a little lower than would have been expected given the market movements as earnings from Walmart provided a bit of a headwind for the models. Walmart missed earnings expectations by almost 11 percent as the company cited increased labor costs, increased freight costs, supply chain issues and different than anticipated consumer spending patterns. Specifically, consumers focused more on grocery items which are lower margin than other items sold at Walmart, such as home goods and toys. Revenues were above analyst expectations, despite Walmart working hard to keep prices down even though the company was feeling the adverse impacts of inflation. TJX Companies, which reported last week and is a core equity position as well, turned in a strong quarter, beating on earnings and slightly missing on revenue expectations. TJX is also in a very good position, moving forward as bigger retailers are looking to offload late arriving inventory, something that TJX is very good at purchasing at a significant discount and then reselling through its stores. Aside from the earnings movers, we saw general selling pressure on a lot of the historically resilient stocks in the hybrid models. While this looked to be a lot of rebalancing by different funds, I will be watching closely to see if a trend emerges that deviates from historical norms and will be making adjustments as necessary.

 

Looking to the Future

 

  • FOMC meeting minutes: FOMC meeting minutes could hold a surprise or two
  • PCE inflation index: PCE index is set to be released on Friday
  • Slow time: We are entering what is typically a slow time of the year for the financial markets

Interesting Fact: 57 Varieties?

There actually aren’t “57 varieties” of Heinz ketchup, and never were. Company founder H.J. Heinz thought his product should have a number, and he liked 57. Hint: Hit the glass bottle on the “57,” not the bottom, to get the ketchup to flow.

 

Source Heinz.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

 

For a PDF version of the below commentary please click here Weekly Letter 5-16-2022

Callahan Capital Management

Weekly Commentary | May 16th, 2022

 

Major Theme of the Markets Last Week: Downtrend Then a Bounce!

The U.S. equity markets continued to move broadly lower last week, even with a bounce of more than two percent on many of the indexes. All four of the major U.S. indexes posted declines in excess of two percent on Friday. This downward trend is getting very long in the tooth. The S&P 500 and the NASDAQ have both posted six consecutive weeks of declines while the Dow posted a seven-week decline and the Russell 2000 posted a four-week decline.

 

Looking back to early 1988, the rarity of the longer declines is evident. There has only been one other instance where the Dow has declined seven weeks in a row, 5/25/2001 through 7/6/2001. There have never been eight weeks in a row of declines for the Dow since 1988. Looking at the NASDAQ, the NASDAQ has experienced six weeks of losses eight times in the past going back to 1988 with the most recent being November of 2012. There has only been one instance of the NASDAQ dropping for seven consecutive weeks and that was during the dotcom bust from 2/2/2001 through 3/16/2001. The current losing streak of six weeks for the S&P 500 is a little more common than the previous two examples as it has occurred nine times since 1988 and the longest losing streak for the index has been eight weeks, which occurred from 2/2/2001 through 3/23/2001. For the Russell 2000, we only have four weeks of losses, which has occurred 65 times going back to 1988. The longest losing streak for the small cap index is seven consecutive weeks, which occurred from 7/24/1998 through 9/4/1998. With the exception of the Russell 2000, we are pushing up against market history this week with the odds of another week of declines being very low, so the bounce we saw on Friday could prove to be the bottom for the financial markets even if it is short lived.

 

The bounce on Friday seemed to largely be driven by Federal Reserve Chairman Jerome Powell who gave an interview to National Public Radio (NPR) on Thursday evening. During the interview, the Fed chair admitted that inflation in the U.S. is too high and that the Fed is behind the curve currently. He reiterated that he expects interest rates to be increased by half a percent at each of the next two FOMC meetings. What was new in his comments was his admittance that executing a soft economic landing may be beyond the control of the Fed and that the process of getting inflation down will likely include some pain. The markets took all of this as a positive development, one in which the Fed’s view is more closely aligned to the view of the financial markets and that the Fed is being more openly honest with itself and the public. With the Fed now being more open, we will see if it will have a more calming effect on the markets longer term or if it causes more knee jerk reactions in the financial markets.

 

Financial News Impacting the Markets

 

Economic data made several headlines last week as key inflation and sentiment indicators were released. The April Core Consumer Price Index (CPI) was released on Wednesday and came in higher than expected at 6.2 percent overall versus expectations of 6 percent. The 6.2 percent reading was below the 6.5 percent reading from March, signaling that we may have already seen peak inflation. The figures were similar when looking at overall CPI, which rose 8.3 percent, more than expected but still lower than the March reading of 8.5 percent. When looking at the producer level, the Core and overall Producer Price Index, released on Thursday, indicated that inflation is still increasing at the producer level but doing so at a slower pace than in March. On Friday, the University of Michigan released its latest consumer sentiment index which fell from 65.2 in April all the way down to 59.1 in May. This significant decline was not anticipated by the markets. The forward-looking Consumer Expectations index also posted a surprising decline for May as consumers dealt with higher prices and some scarcity of products. In addition to the economic data last week there were numerous Fed officials who spoke throughout the week, with the majority of the speeches or interviews pointing to the same thinking—that the Fed is behind the curve a little and that the Fed will be aggressively hiking rates to try to combat inflation. The economic data released last week, combined with the volatility seen in the equity markets pushed some investors into bonds which saw prices rise and yield drop. The 10-year Treasury saw its yield decline from 3.13 percent at the high two weeks ago all of the way down to a low of 2.82 percent last week.

 

Outside of the U.S., the focus of the financial markets remained the war in Ukraine as Russia sanctioned several companies and shut off the flow of natural gas to some countries last week. The actions were in response to both the EU looking at placing more sanctions on Russia and several of the Nordic countries signaling that they would become members of NATO in light of the Russian aggressions. Also in Europe last week, ECB President Christine Lagarde said the current bond buying program the ECB is running could come to an end earlier than expected and that rate hikes could follow closely thereafter. This comes, of course, because of the actions taken by the U.S. Federal Reserve and the need for the developed central banks around the world to be on roughly the same page coming out of the global pandemic.

 

In Asia last week, there was hope that a few areas of China may be able to come out from COVID-19 lockdowns even while other areas are entering lockdowns once again. In Japan, at a meeting of G7 leaders, Japan agreed to ban the importation of Russian oil, a somewhat surprising move.

 

While there were plenty of things for investors to focus on outside of corporate earnings last week, the markets are still in the back end of earnings season. The table below shows some of the better-known companies that reported their earnings last week with companies that beat earnings expectations by more than 10 percent highlighted in green, while those that missed expectations are highlighted in red:

 

Bayer 27% Duke Energy -3% Toyota Motor 39%
Brookfield 14% Nintendo 110%
Disney -10% Occidental Petroleum 8%

 

Nintendo was the big surprise of the week when looking at the above earnings table as the company reported strong sales of 4.11 million Switch gaming consoles during the first quarter. Since 2017, the company has sold more than 107 million Switch units, making it the most successful home gaming console for the company ever. Toyota posted strong earnings during the first quarter despite a continued drag on production numbers form the global chip shortage, which the company has not seen materially ease yet. Disney is discussed in greater detail below in the hybrid strategy update as it is a core equity position of the models. The two major energy related companies that posted results last week were split with Occidental beating both earnings and revenue expectations while Duke Energy missed earnings expectations but beat revenue expectations as the price of oil was a tailwind for much of the quarter for both companies.

 

According to FactSet Research, we have seen 91 percent of the S&P 500 report earnings for the first quarter of 2022. Of the 455 companies that have reported, 77 percent have beaten earnings expectations, 3 percent have met expectations and 20 percent have fallen short of expectations (these numbers are slightly worse than last week). When looking at revenue expectations, 74 percent of the companies that have reported have either beaten or met expectations while 26 percent have fallen short (unchanged from last week). The overall blended earnings growth rate for the S&P 500 for Q1 2022 is currently 9.1 percent. While 9.1 percent may seem like a high number, it is actually the lowest quarter growth rate for the S&P 500 since the fourth quarter of 2020. Forward looking guidance given by companies that have reported has also been pretty weak with 70 percent of the guidance being negative. This week, earnings season moves into the few remaining consumer facing companies that still need to report and earnings season starts to quickly draw to a close. The table below shows some of the better-known companies set to report with the potentially most impactful companies highlighted in green.

 

Applied Materials Home Depot TJX Companies
Cisco Systems Lowe’s Companies Walmart
Deere & Company Target

 

Walmart will likely be the most closely watched earnings report this week as it is one of the largest employers in the U.S. John Deere will be followed more closely than most quarters to see if the company has any information about the situation in Ukraine and the harvest and planting season for that country.

 

Market Statistics

 

  • Equities: Volume remained high last week as we once again saw a week with large equity market movements. Last week was a downward trending week until Friday when the markets posted strong gains, in part due to comments by Fed Chair Powell on Thursday evening, as discussed above. Despite the declines last week, the NASDAQ and the Russell 2000 remain the only two indexes that have officially moved into bear market territory with both the S&P 500 and the Dow having not tripped the 20 percent decline threshold.
    • Dow (-2.14%) – Above Average volume
    • S&P 500 (-2.41%) – Above Average volume
    • Russell 2000 (-2.55%) – Above Average volume
    • NASDAQ (-2.80%) – Above Average volume

 

  • Sector Performance: There were only four sectors of the markets that turned in positive performance last week with Pharmaceuticals leading the way higher thanks to strong earnings and guidance from Bayer. Despite the slightly higher than expected readings on inflation data last week, Consumer Staples and Consumer Goods both had strong weeks as consumer demand for products remains high, even if prices have increased significantly over the past year. Telecommunications and Biotechnology rounded out the top five performing sectors last week as investors seemed to be moving toward areas of the markets that have been hit hard recently in search of more “value” oriented investments.

 

When looking at the sectors that were at the bottom of the performance list last week, there were two major themes: oil and rates. With global demand being called into question by the International Energy Agency (IEA), which downgraded its global oil demand in 2022 due to lockdowns in China and the war in Ukraine, it wasn’t surprising to see Oil & Gas Exploration and Natural Resources make the bottom five sectors. Regional Banks and the Financial Services sectors took two of the bottom five spots as both sectors reacted adversely to the falling rates in the fixed income markets. Aerospace and Defense rounded out the bottom performing sectors last week as Boeing once again sunk the sector, falling nearly 15 percent as there remains all kinds of trouble with management and business operations within that company.

  • Top Sectors: Pharmaceuticals, Consumer Staples, Consumer Goods, Telecommunications, Biotechnology
  • Bottom Sectors: Financial Services, Natural Resources, Regional Banks, Aerospace & Defense, Oil & Gas Exploration

 

  • Commodities: Commodities were mixed last week, with Grains and Agriculture moving higher, while the other major commodities posted declines. The Goldman Sachs Commodity Index (a production weighted index) declined 0.82 percent for the week as Oil declined by 1.03 percent. Oil prices lowered last week as the IEA cut its demand forecast for 2022. Metals were negative last week for the fourth week in a row with Gold, Silver and Copper declining 3.78, 6 and 1.84 percent, respectively. Soft commodities were mixed last week with Livestock posting a loss of 3.77 percent for the week as Grains moved higher by 3.05 percent and Agriculture overall posted a gain of 1.56 percent.

 

  • GS Commodity Index (-0.82%)
  • Oil (-1.03%)
  • Livestock (-3.77%)
  • Grains (3.05%)
  • Agriculture (1.56%)
  • Gold (-3.78%)
  • Silver (-6.00%)
  • Copper (-1.84%)

 

  • International Performance: Global index performance was largely negative last week with 70 percent of the global indexes moving lower, while 30 percent advanced. The average return of the global indexes last week was -1.01 percent. When looking at the global index performances for the previous week, the best performing indexes were in Europe and China. When looking for regions that struggled last week, India, the Middle East and Southeast Asia posted the greatest declines.

 

  • Best performance: Sri Lanka’s Colombo All Share Index (9.03%)
  • Worst performance: Vietnam’s Ho Chi Minh Stock Index (-11.02%)
  • Average: (-1.01%)

 

  • Volatility: The VIX last week had a pretty wild week with the markets’ fear gauge breaking out to the upside on Monday, moving over 35 and above the peak levels from the prior two weeks. The move to the upside was short lived as the VIX moved lower on each of the subsequent four trading days, ending the week lower than where it started. For the week, the VIX declined by 4.37 percent, ending the week below 30 for the first time in three weeks. Closing the week at 28.87 implies a move of 8.33 percent for the S&P 500 over the next 30 days. As always, the direction of the movement is unknown. What is known by the still elevated VIX is that the volatility we have been experiencing recently is likely to stay around for a while longer.

Model Performance and Update

 

For the trading week ending on 5/13/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model -1.42% -10.81% 4.40%
Aggressive Benchmark -2.02% -15.04% 5.50%
Growth Model -1.14% -7.80% 4.00%
Growth Benchmark -1.56% -11.79% 4.58%
Moderate Model -0.87% -4.56% 3.57%
Moderate Benchmark -1.10% -8.45% 3.57%
Income Model -0.76% -2.94% 3.49%
Income Benchmark -0.53% -4.17% 2.19%
Quant Model -4.35% -18.42%
S&P 500 -2.41% -15.57% 10.21%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were two changes to the hybrid models over the course of the previous week with both being the selling of positions. The first change was to sell the full position in The Trade Desk (TTD). This stock was picked up at the height of the pandemic market scare and is a good company but the weakness in the stock tripped the sell trigger, which was set at a 100 percent gain from the initial purchase point in the models. The proceeds from the sale were moved into cash. The second change was to sell the iShares MSCI EAFE small cap value fund (SCZ) as this ETF broke down enough to trip a sell trigger while the position was also detracting from performance more than expected. Proceeds from this sale were also put into cash for future deployment, when an opportunity arises. Disney (DIS) reported earnings last week and missed expectations on both earnings and revenues as analysts had been expecting stronger performance. The market read in-between the lines and saw many positive developments in the earnings release. Revenues for DIS increased 23 percent on a year-over-year basis. The company added 7.9 million new subscribers to Disney+ and expect the streaming offering to be cash flow positive during 2024. Theme-park related revenues came in at $4.9 billion, which is close to the pre-pandemic high levels as U.S. consumers have been flocking to the parks. On the analyst call, DIS management would not comment on the impact, if any, of what some Florida lawmakers are trying to change in terms of the company’s special licensing and tax treatment in the state of Florida. This week, we have two more core equity positions that will report as the reporting season has moved into consumer-focused companies; Walmart (WMT) and TJX Companies (TJX) both report their results.

 

Looking to the Future

 

  • Earnings: Big consumer-facing company earnings could move the markets this week
  • Ukraine: Russia seems to be withdrawing from some areas
  • Slow time: We are entering what is typically a slow time of the year for the financial markets

Interesting Fact: Three Presidents Die on July 4th

It is a fact of American history that three Founding Father Presidents—John Adams, Thomas Jefferson, and James Monroe—died on July 4, the Independence Day anniversary. But was it just a coincidence?

On July 4, 1831, James Monroe, the fifth President, died at the age of 73 at his son-in-law’s home in New York City. Monroe had been ill for some time and newspapers had reported on Monroe’s illness before his passing.

Local and national newspapers were also quick to report after Monroe’s death that they thought his July 4 passing was a “remarkable” coincidence, at the least, since Thomas Jefferson and John Adams had both also died on July 4, 1826 – the 50th anniversary of the Declaration of Independence.

The oddness of the events wasn’t lost on the New York Evening Post in 1831, when the newspaper founded by Alexander Hamilton called it a “coincidence that has no parallel:”  “Three of the four presidents who have left the scene of their usefulness and glory expired on the anniversary of the national birthday, a day which of all others, had it been permitted them to choose [they] would probably had selected for the termination of their careers.”

Source: Constitution Center

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

For a PDF version of the below commentary please click here Weekly Letter 5-9-2022

Callahan Capital Management

Weekly Commentary | May 9th, 2022

 

Major Theme of the Markets Last Week: May FOMC Meeting

Last week was expected to be potentially volatile as corporate earnings and economic data were released and the May FOMC meeting took place. However, the rollercoaster ride that investors experienced in the equity markets was wilder than almost anyone predicted. Monday and Tuesday last week focused on earnings and the VIX slipped from 33 back down under 30. On Wednesday, the markets moved sharply higher following the conclusion of the FOMC meeting, which saw rates increased by 0.5 percent (first half a percent rate hike in the last 22 years) and a press conference that alleviated some of the markets’ fears (more on this later). The VIX closed down by more than 13 percent on Wednesday as the equity markets spiked higher by more than 2.5 percent across the board, marking one of the best days for the equity markets of the past year. This enthusiasm was short lived, however, and investors rethought their positioning in light of the rate hike on Thursday, sending the markets down by more than they gained on Wednesday, and the VIX jumped higher by 23 percent. The movement in the equity market was the worst decline the market had experienced in more than a year with some notable large cap technology stocks not having seen such a bad day since the Great Recession in 2008. Interestingly enough, despite the wide swings both up and down over Wednesday and Thursday, we came into Friday with the U.S. equity market slightly higher for the week, but a downward move for the equity indexes on Friday solidified the fifth weekly decline in a row for the S&P and the NASDAQ, the sixth weekly decline in a row for the Dow and the third weekly decline in a row for the Russell 2000. So, what was markedly different for the markets between Wednesday and Thursday?

 

While the rate hike of 0.5 percent had been locked in for several weeks after Chair Powell said he would raise it 0.5 percent during a speech, the markets had been uncertain about the next rate hike. Going into the meeting, FedWatch was predicting a high probability that the Fed would take an even larger step at the next FOMC meeting and hike rates by 0.75 percent. Chair Powell, when asked in his press conference about the potential for a 0.75 point hike at the next meeting, said it was not “something that we (the Fed) are currently considering.” Markets took this as a dovish surprise from the FOMC meeting press conference and sent the equity markets into rally mode, pushing them to significant gains for the day. However, what Chair Powell said following his comments about the chance of a 0.75 percent rate hike at the upcoming meeting seemed to be missed by the markets. Chair Powell did give the nod to there being two more 0.5 percent rate hikes at the next two FOMC meetings. This would mean a full 1 percent higher Fed Funds rate by the end of the July 27th meeting. This brings rates to the same spot as the 0.75 percent hike followed by a 0.25 percent hike that was predicted prior to Chair Powell’s comments. So, while the path Chair Powell appears to be leaning toward may be slightly different, the end point is the same. Another factor in the markets giving back what they gained on Wednesday was the fact that the fixed income market didn’t buy into this idea of the Fed being able to not move as fast as possible in increasing rates. The bond market sold off on Thursday with the 10-year bond breaking through the 3 percent yield ceiling for the first time since 2018. Other Fed officials on Thursday and Friday were less inclined to completely disregard the chances of a 0.75 percent hike at the June meeting, showing that the future path for rate hikes is far from certain, at least with unanimous votes at the upcoming meetings.

 

One other area of concern that seemed to come out and be glossed over by the markets during Chair Powell’s press conference was his answers about a potential recession. Chair Powell said that he saw it as possible for the Fed to orchestrate a “softish” landing for the U.S. economy. This is not the same as a soft landing, one where there is not a recession caused by the Fed raising rates to combat inflation. “Softish” also does not mean that Chair Powell thinks this will end in a hard landing for the U.S. economy, which would be a fully blown recession that takes a significant amount of action to pull out of. He balanced in the middle with his “softish” term, the first step in what will likely be a very carefully orchestrated balancing act that he will be walking for the next several quarters as the Fed attempts to normalize rates, keep the labor market strong and fight inflation that is running significantly higher than they would like. Finally, at the FOMC meeting, it was announced that the Fed would begin unwinding its balance sheet at a combined (Treasury plus mortgage-backed securities) rate of $47.5 billion monthly, a pace that would be stepped up over the course of three months to get to the goal of $95 billion per month. While this doesn’t mean the Fed will be actively selling these securities, the Fed is allowing maturing securities to not be reinvested.

Financial News Impacting the Markets

In addition to the Fed moving markets last week, investors were focused on economic data that was released, particularly the labor market data. On Monday, both the ISM Manufacturing Employment figure and the ISM Manufacturing PMI figures both missed market expectations as manufacturing growth slowed down in April. On Tuesday, factory orders came in slightly better than expected, giving the markets a little boost. On Wednesday, both the Markit Composite PMI and the Services PMI came in lower for April than they were in March, signaling a slowing down in growth in both indexes. The ISM Non-Manufacturing Employment figure surprised with a decline for the month of April as prices were higher than expected. On Thursday, initial jobless claims came in slightly higher than expected while nonfarm productivity fell by 7.5 percent, far worse than anyone predicated for the first quarter of 2021 compared to a productivity gain of 6.3 percent during Q4 2021. The overall unemployment rate stayed unchanged at 3.6 percent through the month of April. Overall, the labor market is still very tight. As Chair Powell pointed out in his press conference, there are currently 1.9 open and unfilled job positions in the U.S. for each and every unemployed person. The weaker than expected readings on some of the labor and employment related releases last week caused a little concern that the labor market may not be as robust as it was initially thought and the Fed risks doing damage to the labor market by raising rates too quickly.

 

While there were plenty of things for investors to focus on outside of corporate earnings last week, the markets are still in earnings season, even if it is quickly drawing to a conclusion. The table below shows some of the better-known companies that reported their earnings last week with companies that beat earnings expectations by more than 10 percent highlighted in green, while those that missed expectations are highlighted in red:

 

AIG 5% CVS Health 4% MetLife 28%
Airbnb 89% Dominion Energy -1% Moderna 66%
AMD 24% Eaton 1% Pfizer -2%
Anheuser-Busch 12% Enterprise Products Partners 15% Pioneer Natural Resources 6%
Becton Dickinson 7% EOG Resources 8% Public Storage 2%
Block 50% Equinor 2% Shell 12%
Booking Holdings 2886% Illinois Tool Works 2% Starbucks -2%
BP 36% Marathon Petroleum 33% Estee Lauder 14%
ConocoPhillips 1% Marriott International 32% Uber Technologies 33%

 

There was more green than red last week in the earnings table with energy stocks powering upward as well as many smaller technology names. Energy has been the strongest sector in terms of earnings reports this quarter as sky high oil prices caused by the situation in Ukraine led to the U.S. producers’ oil and gas output being much more valuable in the current global markets. Booking Holdings is not a typo above. The markets were expecting a loss of $0.14 per share and the company reported a gain of $3.90 per share, thanks to very strong summer booking demand on its website, primarily by leisure travel and not business travel.

 

According to FactSet Research, we have seen 87 percent of the S&P 500 report earnings for the first quarter of 2022. Of the 435 companies that have reported, 79 percent have beaten earnings expectations, 3 percent have met expectations and 19 percent have fallen short of expectations. When looking at revenue expectations, 74 percent of the companies that have reported have either beaten or met expectations while 26 percent have fallen short. The overall blended earnings growth rate for the S&P 500 for Q1 2022 is currently 9.1 percent. While 9.1 percent may seem like a high number, it is actually the lowest quarter growth rate for the S&P 500 since the fourth quarter of 2020. Forward looking guidance given by companies that have reported has also been pretty weak with 70 percent of the guidance being negative. This week is the start of the big slowdown for earnings reporting as there are fewer than 200 sizable companies set to report their results. The table below shows some of the better-known companies that are set to report with the potentially most impactful companies highlighted in green.

 

Alibaba Brookfield Asset Management Occidental Petroleum
Allianz Disney Suncor Energy
Bayer Duke Energy Toyota Motor

 

Disney and Toyota have the greatest potential to move the markets. Disney is under pressure on the streaming side of its business as other streams have seen a slow down in subscribers or, in some cases, declines in subscriber numbers. Toyota should have comments on the impact the global chip shortage has had on its business, an impact that could be felt by others that have yet to report earnings this season. Next week will be the final week that earnings season is reported on in this commentary.

 

Oil prices made headlines, along with some of the other commodities, as the war in Ukraine continued. Last week, the EU drafted yet another round of sanctions that could be put into place that would ban oil and gas imports from Russia for select countries while allowing other countries who are highly dependent on the flows to keep using them for the time being, provided they work toward fully being off Russia energy in the next few years. This, combined with an unexpected decline of 2.2 million barrels from U.S. gasoline inventories, helped push the price of oil back over $110 per barrel, just in time for the kickoff of the summer driving season here in the U.S. Energy prices and food prices going up are two of the biggest hits to U.S. consumers and they are two of the most difficult to reverse once they get rolling.

 

Market Statistics

 

  • Equities: As described above, it was a rollercoaster of a week for the equity markets with all four of the major indexes closing lower for the week. Volume remained above average thanks to a surge in trading volume on both Wednesday and Thursday. We may have 5 weeks in a row of losses on two of the indexes, but it now becomes historically very unlikely that we continue to see the markets move lower on a weekly basis. Looking back at the data, there is at least a relief rally that can hold in place for a week, but that doesn’t mean the downturn is over.
    • S&P 500 (-0.21%) – Above Average volume
    • Dow (-0.24%) – Above Average volume
    • Russell 2000 (-1.32%) – Above Average volume
    • NASDAQ (-1.54%) – Above Average volume

 

  • Sector Performance: With oil prices jumping higher by more than 6 percent, it was not surprising to see that Energy, Oil and Gas Exploration as well as Natural Resources took the top three performing spots when looking at sector performance last week. Semiconductors came in fourth as strong demand and continued supply chain issues have kept the prices high for the sector, something that will not be going away any time soon. Home Construction rounded out the top performing sectors last week as Home Builders bucked some of the volatility due to strong demand for their homes remaining, despite the higher rates on mortgages.

When looking at sectors that underperformed last week, it was mostly highly leveraged sectors that have a difficult time with the increase in bond yields. Software led the way lower as cyber security companies posted some of the worst performance for the week following weakness out of Palo Alto Networks, Cloudflare and Crowdstrike, each falling more than 10 percent. Residential Real Estate moved lower last week as mortgage rates continued to spike higher, with the average mortgage payment in the U.S. at the new rates breaking over $1,800 per month, an increase of more than $350 since the low mortgage rates of the past 18 months. Consumer Discretionary came in third from the bottom last week as the services economic data and spending data came in a little weak and signaled that the U.S. consumer may not be spending as freely as they once did, when the government stimulus payments were almost constantly hitting their bank accounts. Wrapping up the weak sectors last week was the Medical Devices and Biotechnology sectors, both heavily debt dependent sectors of the markets that moved lower on rising rates and may continue to do so in the future.

  • Top Sectors: Oil & Gas Exploration, Energy, Natural Resources, Semiconductors, Home Construction
  • Bottom Sectors: Medical Devices, Biotechnology, Consumer Discretionary, Residential Real Estate, Software

 

  • Commodities: Commodities were mixed last week, with Oil and Livestock moving higher, while the other major indexes posted declines. The Goldman Sachs Commodity Index (a production weighted index) gained 2.91 percent for the week as Oil advanced by 6.44 percent. Oil prices moved higher last week as the EU looks closer to adding energy sanctions to Russia and as U.S. global gasoline supplies drew down more than anticipated. Metals were negative last week for the third week in a row with Gold, Silver and Copper declining 0.84, 1.81 and 2.88 percent, respectively. Soft commodities were mixed last week with Livestock posting a gain of 0.81 percent for the week as Grains moved lower by 2.97 percent and agriculture overall posted a loss of 1.04 percent.

 

  • GS Commodity Index (2.91%)
  • Oil (6.44%)
  • Livestock (0.81%)
  • Grains (-2.97%)
  • Agriculture (-1.04%)
  • Gold (-0.84%)
  • Silver (-1.81%)
  • Copper (-2.88%)

 

  • International Performance: Global index performance was skewed negative last week with 84 percent of the global indexes moving lower, while 16 percent advanced. The average return of the global indexes last week was -1.63 percent. When looking at the global index performances for the previous week, the best performing indexes (there were only 15 positive indexes in the world) did not seem to have any reasoning behind why they were positive while other geographically close countries and indexes posted declines. When looking for regions that struggled last week, Europe, the Nordic region and Africa posted the greatest declines.

 

  • Best performance: Latvia’s OMX RIGA Index (10.80%)
  • Worst performance: Peru’s Peru General Index (-8.42%)
  • Average: (-1.63%)

 

  • Volatility: Despite the equity markets moving lower for the week, the VIX also posted a decline as the market’s fear gauge appeared to be less fearful than many investors with the roller-coaster trading that took place last week. For the week, the VIX declined by 9.6 percent, ending the week at 30.19. A reading of 30.19 implies a move of 8.72 percent over the course of the next 30 days for the S&P 500. As always, the direction of the movement is unknown. If we continue to get movements like we saw last week, we could see that size movement in a matter of only a few days, much less 30!

Model Performance and Update

 

For the trading week ending on 5/6/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model -1.10% -9.51% 4.64%
Aggressive Benchmark -1.37% -13.29% 5.84%
Growth Model -0.87% -6.72% 4.18%
Growth Benchmark -1.06% -10.39% 4.84%
Moderate Model -0.63% -3.72% 3.72%
Moderate Benchmark -0.75% -7.43% 3.75%
Income Model -0.55% -2.19% 3.62%
Income Benchmark -0.36% -3.65% 2.27%
Quant Model 0.89% -14.69%
S&P 500 -0.21% -13.49% 10.64%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes to the hybrid models over the course of the previous week, but there are a few positions that are getting very close to tripping sell signals. If they should hit the trigger points, the positions will be sold and the proceeds from the sales would be kept in a cash for the time being. Last week, there were four core equity positions that reported their results for the most recent quarter: Republic Services Group (RSG), Jack Henry (JKHY), Marriott (MAR) and Zimmer Biomet (ZBH). All four companies beat earnings expectations as well as revenues expectations for the quarter in what turned out to be a strong week for earnings results for the core equity positions in the hybrid models. This week, there are only two core positions that are set to report, The Trade Desk (TTD) and Disney (DIS). Currently, the hybrid models are positioned to perform well in a continued market downturn, while still having the ability to be adjusted quickly to a changing investment environment.

 

Looking to the Future

 

  • CPI: April CPI reading could come in very hot
  • Bond Yields: Over 3 percent on the 10-year; will rates stop there?
  • Earnings: Final meaningful week of earnings’ reports
  • Market Volatility: Last week was wild and we could be in for more bumps along the way

Interesting Fact: For 100 Years, Maps Have Shown an Island That Doesn’t Exist

Almost nothing is known about Sandy Island, a land mass about the size of Manhattan in the Pacific Ocean off the coast of Australia. Supposedly, explorer James Cook discovered it in 1774, and it began appearing on nautical maps in 1908. It wasn’t until 2012, when a team of Australian scientists set out to survey the island, that they discovered there was no island there at all. The scientists guessed that Cook may have in fact spotted a “pumice raft” of floating volcanic stone and gas. The Sydney Morning Herald even published an obituary for Sandy Island.

 

Source: bbcnews

 

Have a great week!

Peter Johnson

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

For a PDF version of the below commentary please click here Weekly Letter 5-2-2022

Callahan Capital Management

Weekly Commentary | May 2nd, 2022

 

Major Theme of the Markets Last Week: Earnings Roller Coaster

Last week saw a lot of ups and down in a short period of time with the biggest movements being driven by earnings reports and the subsequent market reactions. In total last week, we saw more than 25 percent of the S&P 500 component companies report while nearly 40 percent of the Dow members also reported their results. The table below shows some of the better-known companies that reported their earnings last week with companies that beat earnings expectations by more than 10 percent highlighted in green, while those that missed expectations are highlighted in red:

 

3M 14% CME Group 6% McDonald’s 5%
Activision Blizzard -48% Coca-Cola 10% Merck & Co. 18%
Alphabet -4% Colgate-Palmolive 0% Meta Platforms 7%
Altria Group 3% Comcast 8% Microsoft 2%
Amazon.com -51% Eli Lilly 13% Northrop Grumman 3%
American Electric Power 3% Exxon Mobil -8% Novartis 1%
Amgen 1% Ford Motor -3% PayPal 0%
Apple 6% General Dynamics 5% PepsiCo 4%
Archer Daniels Midland 41% General Electric 20% Qualcomm 10%
AstraZeneca 10% General Motors 34% Raytheon Technologies 14%
Automatic Data Processing 7% Gilead Sciences 20% Sherwin-Williams 5%
Boeing -958% GlaxoSmithKline 14% Stryker 2%
Boston Scientific 3% Honeywell 3% Texas Instruments 8%
Bristol Myers Squibb 2% Humana 18% Thermo-Fisher Scientific 18%
Canadian National Railway -4% Intel 9% T-Mobile 39%
Capital One Financial 4% Keurig Dr Pepper 0% UPS 6%
Caterpillar 8% Kraft Heinz 15% Visa 8%
Chevron -2% Mastercard 27% Waste Management 15%

 

Last week was a difficult week for many companies that reported their results, not so much because of the numbers they posted, but in many cases because of the forward-looking statements or guidance they provided. GE turned in a strong quarter in terms of beating expectations by 20 percent, but was rewarded with its stock falling more than 10 percent after CEO Larry Culp warned investors that headwinds remain for the company and that he was guiding towards the lower end of the guidance range for the future. Amazon missed expectations badly for the first quarter and forecasted weaker Q2 results. The company pointed out inflation, supply chain issues, the pandemic and the war in Ukraine as all having material negative impacts on the company. When a company as large as Amazon reports a poor quarter, it takes down a lot of other companies and stokes investors’ fear that if Amazon is having a hard time dealing with the headwinds, then all of the smaller companies must be feeling the same pressures. Amazon has a significant weighting in the S&P 500 and this weighting is currently evident. The overall blended earnings growth rate for the S&P 500 is currently 7.1 percent, including the poor Amazon numbers; if Amazon was not included in the S&P 500, the earnings would be over 10 percent currently. Other large technology titans, Microsoft, Apple and Alphabet; also traded lower for the week following their earnings reports.

 

According to FactSet Research, we have seen 55 percent of the S&P 500 report earnings for the first quarter of 2022. Of the 275 companies that have reported, 80 percent have beaten earnings expectations, 3 percent have met expectations and 18 percent have fallen short of expectations. When looking at revenue expectations, 72 percent of the companies that have reported have either beaten or met expectations while 28 percent have fallen short. The overall blended earnings growth rate for the S&P 500 for Q1 2022 is currently 7.1 percent. This week is another busy week for earnings reporting as nearly 1,500 companies are set to report their results. The table below shows some of the better-known companies that are set to report with the potentially most impactful companies highlighted in green.

 

Advanced Micro Devices CVS Health Pioneer Natural Resources
Air Products and Chemicals Enterprise Products Public Storage
Airbnb Illinois Tool Works Regeneron Pharmaceuticals
Anheuser-Busch InBev Intercontinental Exchange S&P Global
Becton, Dickinson Marathon Petroleum Siemens
Block Marriott International Starbucks
Booking Holdings MetLife Estee Lauder Companies
BP Moderna Thomson Reuters
Cigna Moody’s Uber Technologies
ConocoPhillips Pfizer Vertex Pharmaceuticals

 

Much like this past week, the current week will likely see more weight being put on the forward-looking guidance than on the previous quarter’s results. The big energy companies will be in focus for any impact they see going forward for the oil market if the war in Ukraine continues.

 

Financial News Impacting the Markets

With the May FOMC meeting occurring this week, the markets last week focused on the economic data that was released. The biggest release of the week was also the biggest surprise and came in the form the preliminary GDP print for Q1 2022, which posted a surprising decline of 1.4 percent while economists had been expecting a reading of 1.1 percent. Looking into the reasoning behind the negative GDP print, it became clear that inventory drawdowns across many business segments as well as a record trade deficit were the two primary drivers of the decline, as depicted in the chart to the right from Econoday. Two bright spots in the GDP report were that consumer spending was up 2.7 percent while business spending on investment was higher by 7.3 percent during the first quarter. These two data points are somewhat contrary to the most recent consumer confidence figures that we have seen over the past few weeks as spending has begun to slow, in part due to inflation. Last week, the PCE price Index for the month of March posted a 6.6 percent reading, solidifying the idea that the Fed will be moving in a big way at the FOMC meeting this week.

 

This week, the May FOMC meeting takes place on Tuesday and Wednesday with the statement and press conference occurring Wednesday afternoon. According to the CME Group FedWatch Tool, there is a 99.8 percent chance that the Fed raises rates by 0.50 percent at this meeting. The odds of the June FOMC meeting holding a 0.75 percent rate hike have increased materially and now stands at a little more than 90 percent. With bond yields moving ever so close to 3 percent last week and inflation continuing to run hotter than expected and continuing to pick up the pace, the Fed is getting backed into a corner. Supply chain issues and the war in Ukraine are not helping things, but are outside of the Fed’s control, so it must use the tools it has to combat what it can. This means it will be hiking rates and doing so aggressively for the remainder of 2022. The risk is that doing so may push the U.S. economy into a recession (this is made all the more likely by the negative GDP print last week). However, if the Fed gets a recession from a more normalized Fed funds rate, it will have the tools to help the U.S. economy through the downturn.

 

Supply chain issues made headlines last week, both from Q1 results during the quarter conference calls but also because of the current situation in China. China currently has millions of people under lockdown in an attempt to stop the spread of COVID-19. However, COVID-19 is still spreading and likely doing so fairly quickly. With the zero-tolerance policy we are starting to see supply chain issues at the ports in China with goods being unable to leave China and some goods not being able to get into China. Last week, China rolled out “mass testing” in Beijing and Hangzhou in an effort to lift some of the lockdowns and get the Chinese economy back moving.

 

Market Statistics

 

  • Equities: Equity markets had a rollercoaster of a week last week with all four indexes posting losses greater than 2 percent for the week. Volume was above weekly average levels with much of the volume being due to earnings reports and investors adjusting their positions to the results. With the declines last week, two of the major U.S. equity indexes are now officially in bear market territory; the Russell 2000 and the NASDAQ both have fallen at least 20 percent from the high levels back in November 2021. The Dow and the S&P 500 have both done a little better, having declined by 11 and 13 percent, respectively.

 

  • Dow (-2.47%) – Above Average volume
  • S&P 500 (-3.27%) – Above Average volume
  • NASDAQ (-3.93%) – Above Average volume
  • Russell 2000 (-3.95%) – Above Average volume

 

  • Sector Performance: Sector performance last week was largely driven by earnings reports from various key companies within different sectors. Home Construction was the top performing sector and the only equity sector to post a gain for the week as the sector benefited from earnings reports that showed that Americans were still spending a significant amount of money on updating their homes. The Pharmaceutical sector came in second last week, helped by a new weight loss treatment from Eli Lilly that looks very promising in people who are obese. Oil & Gas Exploration as well as Energy overall took two of the top five sector spots last week as the sector benefitted from rising oil prices as well as strong earnings results as the price of oil spiked higher during the first quarter of 2022 as Russia invaded Ukraine. Semiconductors rounded out the top five performing sectors last week as strong demand and sold-out order books are still the norm for the sector. So far, there has been little meaningful impact on the sector from the war in Ukraine and the lockdowns currently being experienced in China.

 

When looking at the bottom performing sectors last week, Telecommunications was the standout loser, falling more than 8 percent on the back of weak earnings from a few major companies in the sector. The same companies also had a negative impact on the Multimedia Networking sector which also made the bottom five performing sectors list. Falling new home sales and existing home sales, economic data sets that were released last week, hurt the Real Estate sector. Consumer Discretionary made the bottom performing list last week as U.S. consumers continue to feel the pinch of inflation in many aspects of their lives. Biotechnology rounded out the bottom performing sectors last week as higher potential costs of capital and less than exciting forward guidance on a few earnings calls helped push the sector lower.

 

  • Top Sectors: Home Construction, Pharmaceuticals, Oil & Gas Exploration, Semiconductors, Energy
  • Bottom Sectors: Multimedia Networking, Biotechnology, Consumer Discretionary, Real Estate, Telecommunications

 

  • Commodities: Commodities were mixed last week, with Oil and Grains moving higher, while the other major indexes posted declines. The Goldman Sachs Commodity Index (a production weighted index) gained 1.41 percent for the week as Oil advanced by 1.11 percent. Oil prices moved higher last week as the EU announced it was preparing more sanctions against Russia and that oil may be included in the next round of sanctions. Germany is a key decision maker in the oil decision, and it appears that Germany is starting to come around to the need for the EU to ban Russian oil imports. Metals were negative last week for the second week in a row with Gold, Silver and Copper declining 1.87, 5.69 and 4.96 percent, respectively. Soft commodities were mixed last week with Agriculture posting a loss of 1.16 percent for the week as Grains moved higher by 2.64 percent and Livestock posted a significant loss of 7.48 percent, largely on the increasing feeding costs that are negatively impacting farmers around the world.

 

  • GS Commodity Index (1.41%)
  • Oil (1.11%)
  • Livestock (-7.48%)
  • Grains (2.64%)
  • Agriculture (-1.16%)
  • Gold (-1.87%)
  • Silver (-5.69%)
  • Copper (-4.96%)

 

  • International Performance: Global index performance was negative last week with 77 percent of the global indexes moving lower, while 23 percent advanced. The average return of the global indexes last week was -0.87 percent. When looking at the global index performances for the previous week, the best performing indexes were in Eastern Europe and Africa. When looking for regions that struggled last week, the USA, Western Europe and South America all posted declines greater than 2.5 percent.

 

  • Best performance: Russia’s RTS Index (16.51%)
  • Worst performance: Latvia’s OMX RIGA Index (-7.07%)
  • Average: (-0.87%)

 

  • Volatility: Volatility, as measured by the VIX, last week posted its second week in a row with a gain of more than 20 percent as uncertainty out of some of the largest companies in the world increased investors’ fears. For the week, the VIX increased by 23.61 percent, ending the week at 33.40. This was the first close above 33 for the VIX since January 29th, 2022. The close last week of 33.4 implies a move of 9.64 percent over the next 30 days for the S&P 500, but as always, the direction of the movement is unknown.

 

Model Performance and Update

 

For the trading week ending on 4/29/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model -2.05% -8.50% 4.83%
Aggressive Benchmark -2.40% -12.09% 6.07%
Growth Model -1.55% -5.90% 4.33%
Growth Benchmark -1.86% -9.43% 5.01%
Moderate Model -1.06% -3.10% 3.83%
Moderate Benchmark -1.32% -6.73% 3.87%
Income Model -0.86% -1.65% 3.71%
Income Benchmark -0.65% -3.30% 2.33%
Quant Model -0.75% -15.44%
S&P 500 -3.27% -13.31% 10.70%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

Last week, there were no changes made to the hybrid models, but there were several core equity positions that reported earnings including Coca-Cola (KO), McDonald’s (MCD), Gallagher (AJG), Church and Dwight (CHD), Aptar (ATR), Canadian National Railway (CNI) and Otis Elevators (OTIS). When looking at earnings, all of the above-mentioned companies, with the exception of CNI, beat expectations with CNI falling short by about 4 percent. When looking at revenues, all of the above companies met or exceeded analyst expectations with the exception of AJG and OTIS, both of which missed by small amounts. In listening to the analyst calls and reading through the various earnings reports, there were no major areas of concern for any of the core positions that reported results. This week, there are four core equity positions that are set to report their results for the most recent quarter: Republic Services Group (RSG), Jack Henry (JKHY), Marriott (MAR) and Zimmer Biomet (ZBH).

 

Looking to the Future

 

  • May FOMC Meeting: 50 basis points is in the bag; will Chair Powell signal what is to come at future meetings?
  • Bond Yields: Marching higher, and could adversely impact equity markets
  • Earnings: Up and down so far; will the volatility continue?
  • Volatility: VIX over 30 signifies bumpy road ahead for stock investors

 

Interesting Fact: Sea Lions Can Dance to a Beat.

 

There are only two mammals on Earth with the proven ability to move their bodies in time with an external beat: humans (though not all humans, to be fair) and sea lions. When researchers at the University of Santa Cruz rescued a stranded sea lion in 2013, they found that she was very smart, and she was even able to learn how to dance. Though parrots can also keep a rhythm, it was previously thought that only animals capable of complex vocal learning could do this.

 

Source:news.ucsc.edu

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

For a PDF version of the below commentary please click here Weekly Letter 4-25-2022

Callahan Capital Management

Weekly Commentary | April 25th, 2022

 

Major Theme of the Markets Last Week: Hawk, Hawk, Hawk

The cartoon above from Investing.com accurately portrays what happened to the U.S. financial markets last week. Last week started with the U.S. markets performing well from Monday through Wednesday as investors focused on earnings, which were largely positive. The notable exception was Netflix, which was decidedly negative; more on that below. On Thursday, investors heard from Fed Chairman Jerome Powell and seemed surprised by the hawkish nature of his comments. The Fed is currently in a difficult spot as it attempts to land the U.S. economy softly from the ultralow interest rate environment brought about by COVID-19. Inflation is currently forcing the Federal Reserve to raise interest rates and on Thursday of last week, it appeared that a 50-basis point hike is in the works for the next FOMC meeting, which is just nine days away. There was brief discussion late last week about the Fed moving ahead with a 75-basis point rate hike (would be the first of its kind since Volker in 1994), but this was quickly dismissed as too much of an extreme measure given the current position of the U.S. economy.

 

Markets had become comfortable with the idea that the Fed would increase rates by 0.25 percent at the next few FOMC meetings, but Chair Powell changed things up when he said on Thursday that “50 basis points would be on the table at the May FOMC meeting.” The prospective and now probable 50 basis point hike took some by surprise. What’s more is that following his comments on Thursday last week, the markets are now pricing in a high probability of three rates hikes in a row of 50-basis points each. This fast of a hike in rates could present problems to various sectors of the markets, such as home construction, high-technology debt-heavy companies and smaller companies that rely on loans to get them further along the business cycle. The hawkish tone last week also sent bond yields higher and bond values tumbled lower at the prospect of higher rates much sooner than initially expected. These losses in bonds are becoming compounded on top of losses incurred during the first quarter of 2022, something that many fixed income investors are not used to experiencing.

 

Financial News Impacting the Markets

 

Aside from the Fed’s hawkish comments last week, the U.S. financial markets were mainly focused on earnings as many well-known companies reported their most recent quarterly results. The table below shows some of the better-known companies that reported their earnings last week with companies that beat earnings expectations by more than 10 percent highlighted in green, while those that missed expectations are highlighted in red:

 

Abbott Laboratories 18% Freeport-McMoRan 22% Philip Morris 5%
American Express 12% HCA Healthcare -4% Procter & Gamble 4%
Anthem 6% IBM 4% Prologis 1%
AT&T -1% Intuitive Surgical 6% Schlumberger 6%
Bank of America 5% Johnson & Johnson 3% Tesla 50%
Charles Schwab -9% Lockheed Martin 4% Blackstone 44%
CSX 3% Netflix 21% Truist Financial 10%
Danaher 4% Newmont -3% Union Pacific 1%
Dow Chemical 16% NextEra Energy 7% Verizon 0%

 

The two companies that made the biggest splashes with their earnings last week were Tesla and Netflix. Tesla posted a strong quarter, beating earnings expectations by 50 percent and revenue expectations by almost 10 percent. For the quarter, Tesla delivered 310,048 vehicles to customers, with the Model 3 and Model Y making up 95 percent of all deliveries. Conditions in China came up on the analyst call with CEO Musk telling investors that the company lost about a month of “build volume” in China due to COVID shutdowns. Even with the slight setback, Musk remained confident that Tesla will produce 1.5 million vehicles during 2022. Netflix was a very different story as the company beat analyst expectations on earnings for the first quarter and slightly missed on revenues. The big story, however, was that during Q1 2022, Netflix lost subscribers, the first quarter decrease in users for the company. Some of this was due to Netflix pulling the plug on all Russian users, but the numbers also declined in key areas such as the U.S. and other parts of Europe. Netflix stock nosedived on Wednesday, falling by as much as 38 percent during the day and ending the day lower by a little more than 35 percent. Netflix has been the hardest hit FAANG name for a while now with the stock posting a loss of nearly 70 percent since the November 2021 high levels. With Facebook now called Meta and Netflix performing so poorly, the acronym is hardly ever used in the financial media unless talking about the poor performance of the group after having been such highflyers during COVID-19.

 

According to FactSet Research, we have seen 20 percent of the S&P 500 report earnings for the first quarter of 2022. Of the 100 companies that have reported, 79 percent have beaten earnings expectations, 2 percent have met expectations and 19 percent have fallen short of expectations. When looking at revenue expectations, 69 percent of the companies that have reported have either beaten or met expectations while 31 percent have fallen short. The overall blended earnings growth rate for the S&P 500 for Q1 2022 is currently 6.6 percent. It is still very early in the earnings season, but this week we have 25 percent of the S&P 500 companies reporting their results so we could see the above number change significantly and the tone for the remainder of earnings season really be set in place. The biggest potential market movers to report this week include Apple, Microsoft, Amazon, Meta Platform, Visa and Alphabet (Google).

 

Bond yields last week made many headlines as yields spiked higher following Chair Powell’s comments. The 10-year Treasury saw its yield jump to a high of 2.97 percent after starting the week at 2.83 percent. We also saw the yield curve once again invert on some pairs of Treasuries, but not the 2-year and 10-year Treasuries. Those remained normal throughout the week last week. Some of the downward pressure we saw late last week could have been due to retail investors choosing to get nearly 3 percent in yield from Treasuries as opposed to staying in dividend yielding securities that could be paying 3 percent but are taking on significantly higher volatility risk. As we see bond yields increase, there are more and more investors that move out of equity positions and into bonds to lock in the yields. This could be more prevalent than in past cycles because of how low interest rates are currently. Investors and savers have been penalized over the past few years with rates being near zero and for people who need income from their investments to fund their lifestyles, they have had to move out the risk scale and into dividend paying equities to find income. We may be starting to see signs of this movements reverse with investors moving out of equity positions and back into fixed income.

The economic data released last week presented a mixed picture, as it so often does, with no clear signals for the Fed prior to the upcoming FOMC meeting. The Philly Fed Manufacturing index posted a surprising drop on Thursday. This negative was offset by the Manufacturing PMI, released on Friday, which came in above expectations for the month of April. On the negative side on Friday was the Services side of the PMI, which posted lower growth than expected as consumers appeared to be pulling back on services as a result of inflation in other parts of their budgets. The services sector has been volatile since the middle of last year, but with it being such a large part of the overall U.S. economy, investors pay close attention to how services are doing.

 

Oil prices moved lower last week by more than 4 percent, thanks in large part to uncertainty about the future for global demand. In the U.S., demand remains elevated compared to the past few years as more Americans are getting out and traveling, by car or plane. With the daily releases of oil from the SPR, gasoline prices at the pumps have stabilized at an elevated level, also encouraging people to drive. In Europe, prices at the pump remain elevated and volatile as the war in Ukraine continues to put pressure on Europe to reduce dependence on Russia for energy. So far, the EU has not banned the importation of Russian oil and natural gas, and is unlikely to do so, but the chance is always there. Global demand for oil was lowered last week, as was the global economic growth forecast from the IMF. With lower expected economic growth, there is inherently lower demand for oil. One of the current factors in the lower demand for oil is the lockdown in China.

 

China remains in various stages of lockdowns in key areas of the country, including Shanghai. These latest COVID lockdowns are now stretching into the fourth week in some locations and there does not appear to be an end in sight. China continues to strive for a zero-tolerance policy, something that is next to impossible with the Omicron variant of COVID-19. Production in many industrial areas of China has slowed down meaningfully, as has the export of many products headed to countries all over the world. The latest reports indicate that the current lockdown in China will lower China’s GDP for 2022 by between 2.5 and 3 percent if the lockdowns end relatively soon. If not, more damage will be done to the Chinese economy. With China playing such a key role in the global economy and the U.S. having issues with the Fed’s plan to combat inflation, it is no surprise to see that investors are a bit on edge currently.

 

Market Statistics

 

  • Equities: Last week was an interesting week for the U.S. equity markets as the markets looked poised for a solid week of gains through Wednesday. Then, on Thursday, Fed Chair Powell’s comments spooked investors, caused yields to spike and equity markets to sink into losses for the week. For the week, three of the four major indexes posted above average weekly volume with much of this action coming during the final two days of trading.

 

  • Dow (-1.86%) – Average volume
  • S&P 500 (-2.75%) – Above Average volume
  • Russell 2000 (-3.21%) – Above Average volume
  • NASDAQ (-3.83%) – Above Average volume

 

  • Sector Performance: Sector performance last week was mixed and several different themes that played out throughout the week. The defensive nature of the equity moves late in the week helped drive Real Estate, Consumer Goods and Consumer Staples into the best three performing spots for the week. High interest rates drove the Regional Banks to the fourth best spot as the sector performs better when rates are higher and then can lend money at higher rates. Rounding out the top performing sectors last week was the Transportation sector, which benefitted from the more than 4 percent decline in the price of oil as energy costs are one of the primary factors in the sector’s performance.

 

When looking at sectors of the equity markets that underperformed last week, Telecommunications led the way lower with Netflix being the primary culprit, falling 36 percent on the week and being one of the most heavily weighted stocks in the sector. Biotechnology was hindered last week by the increase in yields. Materials and Oil & Gas Exploration took two of the bottom five spots last week as global demand for raw materials, particularly out of China, was called into question. Software rounded out the bottom performing sectors last week as cyber security companies had a difficult week, falling more than 10 percent and taking down the entire Software sector.

 

  • Top Sectors: Real Estate, Consumer Goods, Consumer Staples, Regional Banks, Transportation
  • Bottom Sectors: Oil & Gas Exploration, Software, Materials, Biotechnology, Telecommunications

 

  • Commodities: Commodities were negative last week, with the exception of Livestock, which posted a solid gain. The Goldman Sachs Commodity Index (a production weighted index) declined 2.95 percent for the week as Oil slumped by 4.10 percent. Oil prices moved lower last week as global demand for oil was called into question with China continuing to lockdown due to COVID-19, a lower global economic growth outlook and faster moves by the Fed on rates. Metals were negative last week with Gold, Silver and Copper declining 2.04, 5.63 and 3 percent, respectively. Soft commodities were mixed last week with Agriculture posting a loss of 1.06 percent for the week as Grains moved slightly lower by 0.06 percent and Livestock posted a gain of 1.27 percent, largely on the increasing cost to feed the livestock pushing up the prices.

 

  • GS Commodity Index (-2.95%)
  • Oil (-4.10%)
  • Livestock (1.27%)
  • Grains (-0.06%)
  • Agriculture (-1.06%)
  • Gold (-2.04%)
  • Silver (-5.63%)
  • Copper (-3.00%)

 

  • International Performance: Global index performance was negative last week with 66 percent of the global indexes moving lower, while 33 percent advanced. The average return of the global indexes last week was -0.85 percent. When looking at the global index performances for the previous week, the best performing indexes were in Eastern Europe and the Mediterranean. When looking for regions that struggled last week, the USA, China and Asia all posted declines greater than 2 percent.

 

  • Best performance: Greece’s Athex Composite Index (3.34%)
  • Worst performance: Vietnam’s Ho Chi Minh Stock Index (-5.44%)
  • Average: (-0.85%)

 

  • Volatility: The VIX, much like the equity markets, experienced two very different halves of trading for the week. The first half (through Wednesday) was very lackadaisical with the VIX meandering aimlessly in a tight trading range. Then on Thursday, the VIX moved higher by about 6 percent on the hawkish tone of the Fed Chairman. On Friday, fear seemed to set in with some investors that the Fed really was going to move faster than expected and the VIX jumped higher by 15 percent for the day. The VIX ended the week at 28.21 the highest weekly close for the fear gauge since early March and only a stone’s throw from the 30 level which historically has been a level that has placed selling pressure on stocks. With a gain of 27.24 percent for the week, the VIX ended the week at 28.21, a reading that implies a move of 8.14 percent over the next 30 days for the S&P 500. As always, the direction of the movement is unknown.

 

Model Performance and Update

 

For the trading week ending on 4/22/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model -1.29% -6.58% 5.16%
Aggressive Benchmark -2.54% -9.98% 6.46%
Growth Model -0.88% -4.41% 4.59%
Growth Benchmark -1.97% -7.75% 5.31%
Moderate Model -0.47% -2.06% 4.00%
Moderate Benchmark -1.40% -5.51% 4.08%
Income Model -0.28% -0.79% 3.86%
Income Benchmark -0.70% -2.69% 2.43%
Quant Model -3.28% -14.80%
S&P 500 -2.75% -10.37% 11.28%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week. However, following Tax Day, there was a model rebalance to ensure that any accounts that were out of balance to their corresponding models were brought back into balance. This process involved buying and selling some positions, especially if funds had been added or withdrawn from an account in the recent past. Last week kicked off earnings season for the core equity positions in the hybrid models with Johnson & Johnson (JNJ), Proctor and Gamble (PG) and Quest Diagnostics (DGX) reporting their results. All three companies beat earnings expectations while JNJ and DGX both slightly missed revenue expectations for the quarter. Overall, it was a solid quarter for all three of the companies and a good start to earnings season for the core equity positions. This week is a busy week for earnings within the core positions with seven companies reporting results. This week kicks off with Coca-Cola (KO), then quickly follows with McDonald’s (MCD), Gallagher (AJG), Church and Dwight (CHD), Aptar (ATR), Canadian National Railway (CNI) and Otis Elevators (OTIS). KO and MCD will be closely watched for any impact that the war in Ukraine is having on the companies as both have exposure in Eastern Europe and in Russa where business operations were wound down during the quarter.

 

Looking to the Future

 

  • Earnings: 25 percent of the S&P 500 report earnings this week
  • Bond Yields: Yields spiked last week; will the elevated levels hold?
  • COVID-19: China lockdowns extended in some areas; global trade starting to feel the impact

Interesting Fact: Cows Have Best Friends 

Recent research from the University of Northampton has highlighted the human-like relationships among cattle. The research found that cows have dedicated friends that they spend time with, day in and day out, and they get stressed when they are separated. Once reunited with their bestie, their heart rates significantly drop (back to normal levels). These findings could greatly benefit the dairy industry, as it’s also been proven that happier cows really do make more—and more nutritious—milk.

 

Source: medium.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

For a PDF version of the below commentary please click here Weekly Letter 4-18-2022

Callahan Capital Management

Weekly Commentary | April 18th, 2022

 

Major Theme of the Markets Last Week: Consumer Price Index (CPI)

Last week, the primary focus of the financial markets in the U.S. was the Consumer Price Index (CPI) reading released on Tuesday. CPI is the consumer-based index that measures things American consumers purchase and provides a good gauge for the inflation pain consumers are feeling. Those pains are certainly high right now. For the month of February, we saw the CPI post a reading of 7.9 percent and there was little doubt that the reading would hit 8 percent or higher in March. Last week, the March reading posted an 8.5 percent reading, the highest level since 1981. Looking at the components of CPI in the table below, it is easy to see where much of the price gains are coming from.

With the price of oil spiking upward in March due to the war in Ukraine, it was not too surprising to see that gasoline saw the highest increase at nearly 50 percent when compared to one year prior. It also accounted for much of the gain of near 32 percent on energy overall during the past year. Used cars and light trucks came in second in the breakdown with those increasing by nearly 35 percent. The gains in used cars and trucks were mainly due to a lack of new car supplies due to shortages of parts, including computer chips, metals for some body panels, air filters and other small electrical components. Currently, it is very common for a new car buyer to be paying well over MSRP as new vehicle inventory is going to buyers who pay cash over MSRP to get to the front of the line for the limited quantities of vehicles. In an extreme case reported by CNBC last week, demand for used Lamborghini Urus SUVs is so high in some locations that buyers are paying $100,000 over asking price to cut ahead of other buyers.

The most direct item affecting many Americans is the inflation being seen at the grocery store with food prices taking off. Officially, food increased right at 9 percent on a year-over-year basis, but how much Americans felt that increase largely depends on what they purchase. Meat prices increased 14.8 percent over the same period, the fastest rate since 1979, while breakfast cereal increased 9.2 percent, the fastest since 1989. The increases at the grocery store are starting to force some consumers to shop for off-brand or store branded items which are typically lower priced. While some of the factors of inflation are expected to recede in the coming months, food prices are not, as the war in Ukraine has adversely impacted the global grains markets as well as the global fertilizer market. With fertilizers and grains going into so much of the grocery store products, it seems the sky-high prices may move even higher and remain at elevated levels for months to come. Travel and leisure activity prices have also been moving higher with airline tickets jumping significantly higher. Most airline tickets are purchased about 90 days before travel, which means that summertime travel is now being booked. The price of that summertime travel can be surprising with some fares being two to three times more expensive than they were prior to the pandemic. Last week, CNBC reported instances where flights overseas to Europe were cheaper than flying from New York City to the west coast of the U.S.

 

The overall gap between the Federal Reserve’s targeted rate of 2 percent inflation and the now 8.5 percent inflation is one of the widest gaps that we have seen in the last 40 years. This runaway inflation hitting the U.S. economy is forcing the Fed to act in raising rates. Last week, there was a lot of discussion about how large of a rate hike we could see at the May meeting, with 50 basis points now being the consensus. The media, taking a 50-basis point hike for granted now, looked forward to the next few meetings as many economists are now predicting two or three consecutive half point hikes at successive FOMC meetings. According to the latest FedWatch data, by the end of the year, the markets are currently pricing in a 73 percent chance that the Fed funds rate will be 2.5 percent or higher, which means we still have a full 2 percent that the rate will need to be raised over the next six FOMC meetings. It is largely assumed that the Fed will not raise rates at the November 2nd meeting as the meeting is very close to the midterm elections and they do not want to politicize a rate hike. This means that, in actuality, we have just five meetings to hike rates by 200 basis points. We should learn a bit more this week about the May meeting as Chair Powell is expected to speak and outline his expectations for a half point hike at the next meeting.

 

Financial News Impacting the Markets

 

Aside from the inflation reading on the CPI last week and what it could mean for the Fed at upcoming meetings, investors focused on the start of earnings season last week as the big banks kicked things into high gear. The table below shows some of the better known companies that reported their earnings last week with companies that beat earnings expectations by more than 10 percent highlighted in green, while those that missed expectations are highlighted in red:

 

BlackRock 7% PNC Financial 18%
Citigroup 16% Progressive -10%
Goldman Sachs 25% U.S. Bancorp 6%
JPMorgan Chase -4% UnitedHealth 2%
Morgan Stanley 22% Wells Fargo 9%

 

As you can see, the big banks, with the exception of JP Morgan, beat earnings expectations with some doing it by a wide margin. While this may seem positive on the surface, the group as a whole moved lower last week as the strong earnings was relative. Expectations had been coming down and the bar was very low for the banks to easily jump over. Concerns from the analyst calls last week focused on inflation, the war in Ukraine and the rising interest rates in the U.S. and around the world. According to FactSet Research, we have seen 7 percent of the S&P 500 report earnings for the first quarter of 2022. Of the 35 companies that have reported, 77 percent have beaten earnings expectations, 3 percent have met expectations and 20 percent have fallen short of expectations. When looking at revenue expectations, 80 percent of the companies that have reported have either beaten or met expectations while 20 percent have fallen short. The overall blended earnings growth rate for the S&P 500 for Q1 2022 is currently 5.1 percent. This is a huge decline from the 41 percent earnings growth rate that we saw during Q4 2021, and something that it seems investors have not fully come to expect given the high levels of the financial markets. Energy, yet to fully report, is expected to post the strongest gain in earnings with a gain of 251.3 percent expected. Much of this gain is coming due to the increased value of both oil and natural gas that drives the sector.

 

The price of oil last week increased to back over $100 per barrel, much higher than we saw this time last year, but almost 18 precent lower than the $120 per barrel prices that it was trading at in March when the fighting in Ukraine was ramping up. Global demand was one of the reasons for the upward move in oil as lockdowns started to ease in some of the more industrial regions of China, thus increasing their demand for oil. OPEC was also partially to blame for the rise in oil prices last week. On Monday, OPEC told the EU that, based on the current and potential future sanctions on Russia, the world is potentially moving into one of the “worst ever oil supply shocks,” and that the cartel would not pump more because of the shortage. This warning came as the EU was pondering full oil sanctions against Russia, something that until now they have been unwilling to do.

 

Bond yields were another factor in the movement of the markets last week as bond yields continued to climb. Last week, the 10-year U.S. Treasury saw its yield move from 2.66 percent up to 2.82 percent, the highest level that we have seen since before the pandemic. We started the year under 1.65 percent on the 10-year, so over the past four and a half months we have seen yields move higher by more than 70 percent. With the move, bond prices have sunk, as have investments in bonds. The significantly higher yields have yet to really impact the U.S. economy, but it is starting to be a significant talking point on the earnings conference calls as, eventually, the cost of capital could become inhibitive to corporate America’s growth. The higher yields in the bond market are also helping push the Fed to act faster than it would otherwise like to do, which in turn will help combat inflation. On a positive note, looking at the Treasury bond yields, there are no parts of the yield curve that are now inverted as all of the bond yields now line up, putting a “normal yield curve” in place.

 

Market Statistics

 

  • Equities: The index performance was a little curious last week in the U.S. as small caps managed to post gains for the week, during a week that saw rising bond yields having a negative impact on the financial markets. Typically, when bond yields are moving higher, it is the NASDAQ and small caps that are the most negatively impacted. NASDAQ was negatively impacted, as expected, while small caps were not. Volume was well below average on three of the four major U.S. indexes, as expected given the 4-day trading week, but the NASDAQ surprisingly managed to post average weekly trading volume, despite the lack of one trading day. Twitter and Elon Musk’s bid to purchase the company had a lot to do with the overall volume experienced on the NASDAQ last week.

 

  • Russell 2000 (0.52%) – Below Average volume
  • Dow (-0.78%) – Below Average volume
  • S&P 500 (-2.13%) – Below Average volume
  • NASDAQ (-2.63%) – Average volume

 

  • Sector Performance: Airlines were the top performing subsector of the markets last week and, given the heavy weighting of the subsector in the Transportation sector, it was no surprise that the Transportation sector was the top performing sector last week. Aerospace and Defense came in a close second last week as the war continuing in the Ukraine helped drive demand for many of the companies in the sector. Basic Materials as well as Energy both made it into the top five sectors last week, thanks to large gains in underlying commodities such as oil and lumber. Home Builders caught a bid last week as the sector had been beaten down over the past month as mortgage rates and building costs have increased. The increase in Home Builders last week looked more like some investors bottom fishing than anything else.

 

When looking at sectors of the markets that underperformed last week, it was a combination of earnings results and higher interest bond yields that seemed to drive most of the performance. Medical Devices, Healthcare and Technology in general struggled on days when we saw meaningful increases in bond yields as these sectors rely on large amounts of debt for their operations. The Semiconductor sector was hit last week as several technology companies announced that they would be increasing their inhouse ability to fabricate their own chips for future use. This is something that Apple and Google have been working on for a long time, but others are starting to see the benefit of fabricating some of their own chips and being more in control of their full product supply chains. Rounding out the bottom performing sectors last week was the Financials sector as the sector officially kicked off earnings season for the first quarter of 2022. JP Morgan set the tone and it wasn’t positive when CEO Jamie Diamond said that he was cautious about geopolitical and economic challenges ahead. The war in Ukraine and the need to write down Russian assets hit JP Morgan and some of the other large financial institutions during the quarter, as did lower loan originations and slower M&A deal flow. At JP Morgan, there is so much concern that the bank announced it would not be deploying any excess capital during the second quarter, choosing rather to keep it on its balance sheet

 

  • Top Sectors: Transportation, Aerospace & Defense, Basic Materials, Home Construction, Energy
  • Bottom Sectors: Financials, Healthcare, Semiconductors, Technology, Medical Devices

 

  • Commodities: Commodities were positive last week, with the exception of Copper, which posted a slight decline. The Goldman Sachs Commodity Index (a production weighted index) gained 6.37 percent for the week as Oil jumped higher by 7.37 percent. Oil prices moved higher last week as parts of China started to reopen, increasing demand for oil, and on news that OPEC told the EU it would be unable to replace the oil coming from Russia that could be blocked by future sanctions. Metals were mixed last week with Gold and Silver advancing 1.42, 3.59 percent, respectively. Copper was the laggard last week as it posted a decline of 0.08 percent, a small decline from the near record prices that it currently trades. Soft commodities were positive last week with Agriculture posting a gain of 0.98 percent for the week as Grains moved higher by 2.20 percent and Livestock posted a gain of 1.81 percent.

 

  • GS Commodity Index (6.37%)
  • Oil (7.37%)
  • Livestock (1.81%)
  • Grains (2.20%)
  • Agriculture (0.98%)
  • Gold (1.42%)
  • Silver (3.59%)
  • Copper (-0.08%)

 

  • International Performance: Global index performance was negative last week with 63 percent of the global indexes moving lower, while 37 percent advanced. The average return of the global indexes last week was -0.28 percent. When looking at the global index performances for the previous week, the best performing indexes were in the Middle East and the Mediterranean. When looking for regions that struggled last week, the USA, China, Africa and India all posted declines greater than 1.5 percent.

 

  • Best performance: Jordan’s Amman General Index (7.21%)
  • Worst performance: Russia’s RTS Index (-11.53%)
  • Average: (-0.28%)

 

  • Volatility: The VIX last week seemed to move in tandem with bond yields. On days that we saw bond yields increased, so too did the VIX. For the week, the VIX increased by 7.28 percent, ending the week at 22.70, the highest weekly close since the middle of March. Historically, as we draw closer to summer trading, the VIX starts to settle down in terms of less day-to-day Trends become longer and more drawn out as overall movement decreases. Currently, it seems that in addition to the normal tendencies of the VIX, the markets’ fear gauge will also have to contend with uncertainty over the war in Ukraine, inflation and the Fed’s actions. At the current reading of 22.70, the VIX is implying a move of 6.55 percent over the course of the next 30 days. As always, the direction of the movements is unknown.

 

Model Performance and Update

 

For the shortened trading week ending on 4/14/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model 0.32% -5.36% 5.38%
Aggressive Benchmark -1.46% -7.63% 6.88%
Growth Model 0.03% -3.56% 4.74%
Growth Benchmark -1.13% -5.90% 5.64%
Moderate Model -0.21% -1.60% 4.09%
Moderate Benchmark -0.80% -4.17% 4.31%
Income Model -0.35% -0.51% 3.91%
Income Benchmark -0.40% -2.01% 2.55%
Quant Model -0.88% -11.90%
S&P 500 -2.13% -7.84% 11.77%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week, with the models performing well on a relative basis, primarily due to the value-focused core equity positions. Marriott was the biggest mover of the week as the hotel operator increased by more than 10 percent, thanks to increased summer bookings and travel plans being made. The company has still not seen a full return of the lucrative business traveler, but is starting to see a slow uptick in business reservations. Other strong performing holdings last week included Nike, Small Cap Value, Canadian National Railway, TJX Companies and Coca-Cola. With Technology having a difficult week, it was not surprising to see that The Trade Desk was the worst performing stock in the core positions, followed closely by the Global Technology Fund. This week kicks off earnings season for the core equity positions in the hybrid models with Johnson & Johnson (JNJ), Proctor and Gamble (PG) and Quest Diagnostics (DGX) set to report their results.

 

Looking to the Future

 

  • Earnings: Disappointing start last week to earnings season; it may get better this week
  • Russia: Pretty quiet week in terms of market reaction last week; will the calm hold?
  • COVID-19: China continues to end some lockdowns

Interesting Fact: Eiffel Tower Grows in Summer

The Eiffel Tower gets taller by up to 6 inches during the summer, when the temperature reaches as high as 40°C. Extreme heat causes the metal at the base to expand, increasing the height of the 300-metre-tall tower. It also causes the top of the tower to tilt away from the sun by up to 7 inches.

 

Source: inshorts.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

For a PDF version of the below commentary please click here Weekly Letter 4-11-2022

Callahan Capital Management

Weekly Commentary | April 11th, 2022

 

Major Theme of the Markets Last Week: The Fed Will Be Moving Quickly

The U.S. financial markets were focused on the Federal Reserve last week, with both the meeting minutes from the March meeting as well as several speeches given by key Fed officials causing market movement. The big news of the week came in the form of the March FOMC meeting minutes where it became clear to the U.S. financial markets that the Fed will be moving faster than was expected, both in terms of interest rate movements and in the balance sheet runoff. On the interest rate front, “Many participants noted that … they would have preferred a 50-basis-point increase in the target range for the federal funds rate at this meeting,” though “In light of greater near-term uncertainty associated with Russia’s invasion of Ukraine, they judged that a 25-basis-point increase would be appropriate at this meeting,” the minutes stated. The inclination to raise rates by 0.5 percent in March (a move of that size has not been done since 2000) led Fed watchers and the financial markets to fully price in a rate hike of 0.5 percent at the May FOMC meeting and a second 0.5 percent rate hike at the June meeting. These expectations of the Fed funds rate being higher by 1 percent from current levels at the conclusion of the June meeting caused the fixed income market here in the U.S. to see yields jump higher during trading. The yield on the 10-year Treasury moved from a close of 2.38 percent the prior week to a close of 2.65 percent last week.

 

In addition to the meeting minutes showing the quick pace of rate movements coming in the near future, the most dovish Fed Governor Lael Brainard gave a surprisingly hawkish speech on Tuesday when she said that the Fed would “reduce its balance sheet at a rapid pace as soon as the May meeting.” The explosive growth of the Fed’s balance sheet has been a hot topic for the U.S. financial markets for a long time as we have been watching it expand at an alarming rate. It sits at more than $9 trillion after having more than doubled due to the COVID-19 pandemic. The chart below from the Federal Reserve’s FRED system shows the growth of the Fed’s balance sheet since 2004:

The meeting minutes on Wednesday held some more details about the Fed plan going forward that were lacking in the Fed officials’ speeches given on Tuesday. According to the meeting minutes, the Fed is considering reducing its balance sheet by $95 billion per month, higher than the expected $80 billion per month, but not as high as some of the worst-case scenarios that some economists had released, showing a reduction of $120 billion per month. The reduction will come in the form of $60 billion per month in Treasuries and $35 billion per month in mortgage-backed securities (MBS). The runoff will be phased in over 3 months, which is also a bit faster than expected and caught some investors off guard. The biggest question for many investors is what will happen to the MBS market as the Federal Reserve has been such a significant player in the market for several years now. One thing to clarify is that this is a runoff operation that the Fed will be doing, meaning that it will not be reinvesting securities as they mature, the Fed is not going to the open market and outright selling securities. The likely outcome of the action is that it will put upward pressure on longer term interest rates which will help combat inflation. Both the rate movements as well as the balance sheet runoff operation Is a direct result of inflation being too high currently in the U.S. economy with indications that the March print for inflation, when released later this month, will show a reading higher than 8 percent for the first time since the early 1980’s. As previously mentioned, the U.S. financial markets are in a bit of precarious spot watching the Fed, which is also in a tight spot; as it wants to cool inflation without pushing the U.S. economy into a recession.

 

Financial News Impacting the Markets

 

All eyes were on the jump in yields and the fixed income markets last week and yet one topic in the fixed income market was glossed over. Two weeks ago, we had an inverted yield curve with the 10-year Treasury yielding less than the 2-year treasury, a tell-tale sign of a recession to come. Last week, the large moves in the long end of the yield curve caused the curve to normalize, meaning it was no longer inverted as the 2-year treasury yielded less than the longer dated treasuries. While this change does not negate the inversion that did occur in the past month, it does cause investors to question how long we have until the forewarned recession hits. Many economists and market watchers alike are currently saying that the likelihood of a recession due to the Fed’s actions over the next year or two will push the U.S. economy into a technical recession, but it will be a recession that does not have a material impact on the U.S. economy.

 

The U.S. labor market had an eventful week last week as the new weekly jobless claims posted a 166,000 reading, the lowest level since 1968. Two weeks ago, the overall unemployment rate decreased from 3.8 percent down to 3.6 percent, only one tenth of a percent above the 3.5 percent we saw in March of 2000, just before the pandemic hit. At that time, it was the lowest rates for unemployment that the U.S. had seen in the past 50 years. Along with the strong unemployment rate and the jobless claims, last week cleared the path for the Fed to raise rates without fear of causing problems for the U.S. labor market.

Many investors were watching the home builders last week as the sector continued to struggle with rising interest rates. The average rate for a fixed 30-year mortgage last week crossed over 5.2 percent. This jump in rates (they had been below 2.7 percent as recently as January of 2021) is rapidly increasing the potential mortgage payments for new home buyers. This is hitting at the same time that inflation for building materials is hitting home builders as they have to raise prices to offset their higher input costs. We are starting to see more headlines about the housing market and sellers starting to be fearful over not being able to sell their properties at the price they have come to expect due to higher rates. As mentioned above, rates are only just starting to move higher and have a significant way to go. The spillover from the housing market and higher rates is starting to be acutely felt in the banking sector and refinancing has fallen precipitously. The chart to the right from investing.com shows just how quickly the refinancing index has declined over the past year. We could see the impact from the decline in refinancing activity first with some of the refinancing specified companies such as Rocket Mortgage, which has seen its stock price fall by more than 50 percent over the past 9 months. While the refinance business isn’t a major part of any of the large financial institutions, it will still be interesting to hear what, if anything, is said about the current slowdown during their quarterly earnings calls which are released later this week.

This week is the official kickoff to earnings season with many of the large financial institutions reporting their results for the first quarter of 2022. The table below shows the ten financial companies reporting this week that will garner the most attention. With the war in Ukraine breaking out during the quarter, special attention by management will be paid to any impact the war or the sanctions on Russians are having on their businesses. The spike in volatility around oil, energy prices, volatility and bond yields should have been a positive development for many of the companies that have strong trading desks. The group will set the tone for an earnings season that has been slowly being revised downward in many ways after multiple strong quarters coming out of the slump caused by COVID-19.

Problems for the U.S. and global financial markets because of COVID-19 may not be finished yet. China continues to see a very fast uptick in cases now widespread throughout the country. Shanghai, as well as several key industrial areas of China, remain on lockdown with no foreseeable end in sight if the Chinese government continues to insist on a zero-tolerance policy. The table below from Goldman Sachs shows China (upper right dot) as currently experiencing near 100% of the peak new cases on a 7-day moving average level that was seen at the height of the pandemic earlier. China at more than 60 percent of the highest weekly changes in new cases since the start of the pandemic as well. All of this signals that China is not out of the woods with COVID-19 and the world is waiting to see if supply chains will once again come under pressure due to China being shut down. The high technology sector and semiconductors are likely to be the first to feel the pinch as these sectors were already under supply chain issues and this will only make the situation worse.

 

Ukraine also made market moving headlines last week, as the fighting rages on in some areas, and Ukraine is left picking up the pieces in others as the Russian army pulls back. Commodity prices continued to move higher for all of the planted commodities coming out of the region as parts of the 2022 harvest look like they will go unplanted due to the war. Oil prices were little changed last week as oil traders appear to be taking a wait-and-see-what-happens-next approach to the ongoing war. While the flow of arms into Ukraine from foreign countries has been very large, the pace is starting to slow as countries’ stockpiles have been depleted. This could present a positive tailwind for many manufacturers of weapons as countries will need to restock for potential future use, and we saw many of the defense contractor companies turn in good relative performance last week. On a more sobering note, last week was the Chairman of the U.S. Joint Chiefs remarks to Congress. He said the current conflict will not be a conflict that will be measured in months but rather a conflict that will be measured in years. This is not the situation the financial markets had hoped for as it leaves open the possibility of issues coming from the region in the energy markets, commodity markets and other markets for potentially years to come.

 

 

 

Market Statistics

 

  • Equities:S. equity markets all posted losses last week with the rise in interest rates on the back of the Fed minutes and comments having the most impact. Large healthcare related companies helped keep the Dow the strongest of the major indexes last week as United Health led the way with a gain of 6.5 percent. Volume was above average on three of the four major indexes as investors adjusted their positioning to both small cap and technology companies that are heavily reliant on cheap debt for funding their operations.

 

  • Dow (-0.28%) – Average volume
  • S&P 500 (-1.27%) – Above Average volume
  • NASDAQ (-3.86%) – Above Average volume
  • Russell 2000 (-4.62%) – Above Average volume

 

  • Sector Performance: Healthcare was the top performing sector last week as favorable investment research notes from Jefferies and others helped push the sector higher. Health insurers in particular did very well last week as the group, set to start reporting earnings this week, had lowered their earnings bar in light of Omicron, only to find the subvariant of COVID-19 to be less impactful than expected. At this point, Healthcare looks to be one of the bright spots in terms of exceeding earnings expectations during the upcoming earnings season. This positivity carried over to and helped drive Pharmaceuticals and Healthcare Providers into the top five preforming sectors as well last week. Energy and Consumer Goods both also moved higher last week on the hope of a strong quarter, ahead of what could be more difficult quarters going forward, if the situation in Ukraine doesn’t resolve itself and if inflation continues to run hot here in the U.S.

 

When looking at sectors of the markets that underperformed last week, Semiconductors led the way lower as Nvidia saw negative press about excess inventory of graphical processing units (GPUs) and customers cancelling their orders for new GPUs. For the week, Nvidia fell by more than 13 percent, taking down many other chip makers as well. Airlines had an awkward and difficult week last week as JetBlue jumped into the fray to try to buy Spirit Airlines, which had already received a good offer from Frontier Airlines. For the week, JetBlue closed down nearly 20 percent, while discount airlines such as Southwest Airlines and Alaska Air both ended down nearly 10 percent. Technology in general, Home Construction and Multimedia Networks all made the bottom performing lists last week, largely due to the upward moves in bond yields and their increasing costs of capital.

 

  • Top Sectors: Healthcare, Pharmaceuticals, Healthcare Providers, Energy, Consumer Goods
  • Bottom Sectors: Multimedia Networking, Home Construction, Technology, Transportation, Semiconductors

 

  • Commodities: Commodities produced a mixed week last week as gains in metals and some soft commodities were offset by a small loss in oil prices. The Goldman Sachs Commodity Index (a production weighted index) gained 0.04 percent for the week as Oil moved lower by 0.08 percent. Oil held steady throughout much of the week as the world oil markets digested the outflows of oil from strategic oil reserves around the world as there remains a conflict premium due to Ukraine and Russia. Metals were positive last week with Gold, Silver and Copper advancing 1.10, 0.35 and 0.17 percent, respectively. Soft commodities were mixed last week with Agriculture posting a gain of 2.81 percent for the week as Grains moved higher by 6.23 percent and Livestock posted a loss of 2.25 percent.

 

  • GS Commodity Index (0.04%)
  • Oil (-0.08%)
  • Livestock (-2.25%)
  • Grains (6.23%)
  • Agriculture (2.81%)
  • Gold (1.10%)
  • Silver (0.35%)
  • Copper (0.17%)

 

  • International Performance: Global index performance was slightly negative last week with 57 percent of the global indexes moving lower, while 43 percent advanced. The average return of the global indexes last week was -0.31 percent. When looking at the global index performances for the previous week, the best performing indexes were in Eastern Europe and the Middle East. When looking for regions that struggled last week, Asia and the USA were at the top of the list, followed closely by South America.

 

  • Best performance: Turkey’s BIST 100 Index (6.29%)
  • Worst performance: Hungary’s Budapest Stock Exchange (-6.31%)
  • Average: (-0.31%)

 

  • Volatility: The VIX had a pretty uneventful week last week, as it was a little more volatile than it was during the calm week two weeks ago, but still very calm relative to what we have seen in the past two months. For the week, the VIX gained 7.79 percent and ended the week at 21.16. A reading of 21.16 implies a move of 6.11 percent for the S&P 500 over the next 30 days, but as always, the direction of the movement is unknown.

 

Model Performance and Update

 

For the trading week ending on 4/8/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model -0.64% -5.65% 5.34%
Aggressive Benchmark -1.33% -6.26% 7.13%
Growth Model -0.23% -3.59% 4.74%
Growth Benchmark -1.03% -4.82% 5.83%
Moderate Model 0.16% -1.39% 4.13%
Moderate Benchmark -0.73% -3.39% 4.45%
Income Model 0.39% -0.16% 3.98%
Income Benchmark -0.35% -1.62% 2.61%
Quant Model -1.85% -11.12%
S&P 500 -1.27% -5.83% 12.16%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week. Movements in consumer staples and value-focused companies helped drive the outperformance of the lower risk level hybrid models last week as they were beneficiaries of investors moving out of technology investments. There were no core equity positions that announced earnings last week and there are none scheduled to release their earnings this week as next week is the start of earnings season for the core positions of the models. Overall earnings for the models are expected to be good with inflation being the single largest wild card factor, as is the case with many for the stocks in the major indexes.

 

Looking to the Future

 

  • Earnings: Earnings season starts this week
  • Inflation: Latest inflation economic data points are set to be released
  • Russia: Pretty quiet week in terms of market reaction last week; will the calm hold?

Interesting Fact: Monthly Mortgage Payments

Here’s a not-so-fun fact: The monthly mortgage payment it takes to buy the typical home in the U.S. is now up by a staggering 55% compared with the start of last year. That’s because of the dramatic rise in mortgage rates in recent weeks on top of price gains in the hot housing market.

Here’s how the numbers look for the typical home in the U.S.: The median price for a home has risen from $309,200 in December 2020 to $357,300.

Over that same period, interest rates rose from 2.67% to 5.08% this week. With a 10% down payment, that has pushed the monthly payment up from $1,124 to $1,742 — a whopping 55% increase. That’s upwards of $600 a month on that $357,000 home. That’s the impact of higher prices together with rising rates.

If you look at interest rates alone, the 2 percentage-point rise in interest rates we’ve seen so far adds $115 to the monthly payment for every $100,000 you borrow on a 30-year loan.

Source: NPR.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

For a PDF version of the below commentary please click here First Quarter 2022 in Review

First Quarter 2022 in Review:

We entered 2022 with the fear of yet another new variant of COVID-19 hanging over the U.S. economy as Omicron was just picking up steam after having quickly spread around most of the developed world. The new variant was much more contagious than previous variants, but proved to be much less lethal and problematic for most people. By the middle of January, the U.S. had seen the peak of the Omicron wave and was beginning to move back into more “normal” times as COVID-19 restrictions were being dropped and guidelines for things such as quarantine duration were loosened. With it becoming clear that the world would need to adapt and live with COVID-19 and future variants, investors seemed to come to the realization that the Fed would also have to begin moving toward some semblance of normality with its monetary policy actions.

 

Going into 2022, the CME Fed Market watch tool was showing a prediction of three rate hikes by the Federal Reserve over the course of 2022. This tool is based on large institution money managers positioning for future rate movements through the options markets and over time has proven to be spot on. There was an FOMC meeting held in January with a press conference that followed, at which Fed Chair Powell struck a more hawkish tone than the market was anticipating, causing investors to quickly try to adjust their fixed income positioning. Chair Powell reiterated that he was closely watching inflation and that inflation, and not the labor market, would be the impetus for the Fed to take action and raise rates. He also said that all FOMC meetings in 2022 were meetings at which a rate hike would at least be debated. A surprise coming out of the January FOMC meeting was that Chair Powell opened the door to a balance sheet reduction plan potentially coming during the second half of 2022, not just the turbo taper that was already in place but an actual selling of balance sheet assets to get the Fed’s balance sheet back to a more “normal” size. Following the January FOMC meeting, the number of rate hikes during 2022 jumped up to five, and the first signs of an elusive 0.5 percent rate hike began to be discussed by economists.

 

The half a point rate hike discussion got a boost in mid-February when St. Louis Fed President James Bullard, probably the most hawkish and outspoken member of the Fed, announced that he wanted to see the Fed funds rate at 1 percent by the middle of the year. Given the number of FOMC meetings between February and the end of June, for the math to work out, one of the meetings needed to hold a half percent jump in rates. Other Fed officials were quick to say that no decision had been made and a discussion and analysis of incoming economic data was all that would force the Fed to act. The fixed income market started to see bond yields move higher, however, in what could have been seen as a play to force the Fed’s hand in the future.

Bond yields are very sensitive to the Fed and its rate setting policy. Yields have been extraordinarily low for a significant period of time as the Fed helped the U.S. economy fight through COVID-19. The 10-year U.S. treasury bond is the most commonly quoted and most watched bond with the highest trading volume for investors looking for what is happening in the fixed income market. We started 2022 with the 10-year yielding 1.61 percent and saw the yield jump to more than 2 percent by the middle of February following the January FOMC comments and President Bullard’s remarks. It was the first time that the 10-year posted a yield over 2 percent since July of 2019. The spike in bond yields caught investors off guard and created a significant amount of volatility in the equity markets as investors grew concerned that the Fed was significantly behind the curve. The move proved short lived as fears around Ukraine started to make headlines by mid- to late-February and the 10-year dropped to a low of 1.67 percent in early March as demand soared for the safety of the bonds.

 

In early February, the global intelligence community began to notice that Russia was amassing troops near the board with Ukraine in southern Russia. Tensions quickly rose as Russia began military exercises in the region as well as in Belarus, where Russia is essentially in control of the federal government. In the back half of February, Russia moved into the eastern regions of Ukraine after proclaiming them breakaway Russian states. As suspected, Russian President Putin had higher ambitions than just taking over two regions of Ukraine that were largely comprised of Russian people; he kept moving toward Kyiv and the military actions started to intensify with missile strikes and bombings occurring throughout Ukraine nearly round the clock. Global commodities were the first to react to the invasion with oil prices spiking higher and topping out at more than $130 per barrel of crude oil. Natural gas prices soared on fears that Russia may turn off the gas flow to Europe while Europe was moving through the end of winter. Other commodities, particularly nickel and wheat, jumped higher as sanctions were slapped on Russia and Russia officials and individuals close to President Putin. The eastern region of Ukraine supplies a meaningful percentage of all the globally exported wheat and the war broke out just ahead of the start of the planting season with farmers left with no way to get seeds in the ground for the 2022 harvest. What is more is that the region of Ukraine and Russia produce a significant amount of the world’s potash and fertilizer, so the cost of farming went up globally just on fears of supply shortages of critical ingredients of farming. Russian oil was banned by the U.S. and the UK, but not by Europe, which is too dependent on Russia for their energy needs. The U.S. appealed to OPEC+ to release more oil, but the group declined to increase output production above the previously agreed to 400,00 barrels per day of oil. As to the reason for not increasing production, the group cited that there was no shortage of global oil supplies. The decision may have also had something to do with Russia being a member of OPEC+ and OPEC+ not wanting to start an internal fight with one of its important members. Late in the quarter, President Biden announced that he was releasing up to 180 million barrels of oil from the Strategic Petroleum Reserve in the U.S. at a rate of 1 million barrels per day for 180 days. The move was followed by several other countries in the world as everyone attempts to deal with near record high oil and gasoline prices. The move in the U.S. was partially political as incumbent parties never fare well in the midterm elections in the U.S. when gasoline prices are meaningfully higher than when the took office. We ended the quarter with Ukraine having put up enough of a fight, surprising Russia enough that Russia has pulled back troops from some of the central areas of Ukraine such as Kyiv in order to focus on trying to win over the eastern region of the country. The situation remains fluid and investors are gaming out various scenarios, none of which are very positive at this point.

Despite the situation in Ukraine during the back half of the first quarter 2022, investors continued to contend with Federal Reserve actions. In early March, at a Congressional testimony before Congress, Chair Powell made it clear that the Fed would be hiking rates by 0.25 percent at the next FOMC meeting. He also stated that the Fed would “move carefully and nimbly” when considering future rate hikes. Many of the large financial institutions started putting out projections with everything from 5 to 9 more rate hikes in 2022, with some of the hikes being half point hikes while others were more normal quarter point raises. Following through with his comments at the March FOMC meeting, the Fed raised rates by a quarter point and started the Fed’s liftoff of interest rates. Economic data was the main driving force behind the Fed taking action on rates in March as the inflation data in particular was running far too high to continue to ignore.

Throughout the first quarter we received troubling economic data points, especially on the inflation front. We started the first quarter with inflation, as measured by the Consumer Price Index (CPI), running at 7 percent. By the end of the quarter, the figure had moved up to 7.9 percent through the end of February, a 40-year high level. March also looks like it will push over 8 percent as many of the energy and food related cost increases occurred during March. The Fed doesn’t like to use the CPI data when looking at inflation, choosing rather the PCE price index. This index was also sky high during the quarter, pushing from below 6 percent to over 6.5 percent during the quarter and likely moving north of 7 percent early in Q2. The Fed is clearly behind the curve when trying to contain inflation. Prior to this, its target rate of inflation was two percent annually and for the longest time the Fed viewed the inflationary pressure as transitory. The biggest drivers during Q1 of the inflation spike was energy costs, used car costs due to supply chain issues and food cost increases.

While we saw a relatively strong holiday shopping season at the end of 2021 as we moved into 2022, it became clear that global supply chains were still stressed, as we saw durable goods orders for December and January come in lower than expected due to a lack of products for purchase. This lack of supply curtailed into slower consumer demand as inflation started to eat away at consumer confidence and thus big-ticket purchases. As we came to the end of the first quarter, consumer sentiment was moving lower despite record high wage growth and very low levels of unemployment. Labor costs was a focal point of the Q4 earnings season, which was released during first quarter, as companies dealt with increasing labor costs in different ways. Ultimately, the cost of labor didn’t stop the earnings season from posting a stellar growth rate of 30.7 percent for the S&P 500, according to FactSet Research, better than the expected 20.9 percent going into the quarter. However, many companies called out the situation unfolding in Ukraine as well as inflationary pressures as headwinds for future growth. Growth expectations have been steadily declining over the past few weeks.

We ended the first quarter of 2022 with COVID-19 once again causing some problems, this time in China where millions of people were under strict lockdown measures as the country continues to pursue a zero case policy that is quickly becoming unattainable. Global manufacturing is once again starting to slow down due to China shutting down, and we are probably several weeks if not a month or more away from the COVID-19 situation getting better in China.

Looking to the future:

The future for the financial markets looks uncertain, as it normally does, but this time there are clearly more warning signs and headwinds than normal. For the U.S. market in particular, the future course of inflation and, with it, the future course of the Federal Reserve policy will be the key to market movements. Rarely if ever has the Fed been in this place before, with very low rates that need to rise, near record low unemployment, borderline runaway inflation and global supply chain issues that the Fed can have very little impact on. The Fed is currently walking a tight rope of sorts in its balancing act. Act too fast and push the U.S. economy into a recession. Act too slow and inflation runs away to the upside and pushes the U.S. economy into a recession. The fixed income market also has a yellow light going off with a yield curve inversion.

Toward the very end of the first quarter, we saw the fixed income yield curve start to invert. An inversion is when the shorter maturity bonds are yielding more than longer dated bonds. First, we saw the 7-year, 5-year and 3-year bonds all yield more than the 10-year bonds. But the gold standard to watching for an inversion is the 10-year and 2-year inverting. We saw this pair invert during the last few days of trading during the first quarter and it is a telltale sign that a recession will be coming in the future. The problem is that it is not very specific about the timing of a recession with the average length of time between the inversion and the start of the recession being about 15 months, when looking at the past six inversions. Will we be in a recession during the next quarter or two based solely on the yield curve inversion? It is highly unlikely. However, we have a lot more going on than just a yield curve signal.

 

The situation in Russia, while it looks to be slightly deescalating, will remain one of the biggest wildcards moving forward. Russia is not perceived in a positive light at the moment, and we have yet to see how President Putin will react to the bungled situation in Ukraine, after what was supposed to be an easy victory. The global energy markets remain the most at risk as Russia has the most sway in this area of the global economy. However, we could see the spillover of sanctions start to impact other areas of the global economy as well, such as agriculture and industrial metals, both of which have meaningful exposure to Russia.

 

COVID-19 remains lurking in the shadows. So far, the variants that have emerged have been less problematic but more contagious. But we haven’t gone a fully quarter yet without the emergence of new variants or waves of infections, so this pandemic could flare up once again. On a positive note, despite all these potential negatives, corporations around the world are becoming very adept at adjusting to new market conditions and have some of the strongest financial balance sheets that we have seen in a very long time. In the past, the financial markets have led the way higher, just like they could easily do again.

 

Peter Johnson

Callahan Capital Management

 

First Quarter 2022 Numbers:

 

The following is a numerical representation of the first quarter of 2022. Performance for the four major U.S. indexes and the VIX were as follows:

 

Index 1st Quarter 2022
Dow -4.57%
S&P 500 -4.95%
Russell 2000 -7.80%
NASDAQ -9.10%
VIX 19.40%

 

It was a wild ride for the U.S. markets during the first quarter of 2022. We started the quarter with the latest COVID-19 variant (Omicron) spreading quickly around the developed world, including the U.S. Fears of potential lockdowns and continued struggles with logistics helped push inflation to multiyear highs that ultimately forced the Fed to raise rates at the end of the quarter. About halfway through the quarter, Russia’s invasion of Ukraine hit global financial markets as the outcome of the actions was unclear and caused a spike in global oil prices. Ending the quarter with interest rates sharply rising, war continuing in Ukraine, consumer confidence starting to falter and inflation running rampant, it was not at all surprising to see that the VIX increased by nearly 20 percent during the quarter. What is surprising is that the VIX only increased by 20 percent during the quarter. At one point in early March, the VIX was up more than 111 percent on a year-to-date basis.

 

Looking globally, performance was tilted negative during the first quarter of 2022. In total, 61 percent of the world’s stock market indexes posted losses for the quarter, with the average return of the global indexes being a loss of 1.42 percent. When looking at the top performing regions for the quarter, the Middle East and South America stand out as the best regions. Not surprising, when looking at underperforming regions of the world for the quarter, we find Russia, Eastern Europe, Europe and China. The top three performing indexes for the first quarter of 2022 were:

 

Country Index 1st Quarter 2022
Turkey (2nd Quarter in a row) BIST 100 INDEX 20.2%
Namibia Namibia Overall Index 19.2%
Bosnia and Herzegovina Bosnia BIRS Index 18.6%

 

Globally, the bottom three performing indexes for the first quarter of 2022 were:

 

Country Index 1st Quarter 2022
China Shenzhen SE Composite -16.29%
Sri Lanka Colombo All Share Index -27.17%
Russia RTS Index -36.0%

 

The U.S. dollar continued to be seen as a safe haven asset in the currency markets around the world during the first quarter of 2022. With commodity prices soaring during the back half of the quarter, it was not surprising to see the Brazilian real turn in a strong quarter. Favorable government policies in Brazil, such as low interest rates and strong foreign inflows of money into the country, helped push the real higher during the quarter. Sri Lanka was a mess during the first quarter of 2022 with both its currency and stock market plunging more than 27 percent. The country is currently struggling with depleted foreign currency reserves as well as depleted government capital accounts. As of February, the country was down to just over $2 billion in total assets and was seeking assistance from the IMF. The government’s inability to pay for fuel that was waiting to be offloaded in Colombo led to rolling power outages across the island at several points during the quarter and even required the stock market in the capital city to be halted. Sri Lankan President Gotabaya Rajapaksa ended the first quarter under immense pressure from the people who are calling for a regime change in the government.

 

Currency Change
US dollar 2.61%
Brazil real 17.49%
Sri Lanka rupee -30.98%

 

For those who follow and are interested in the style box performance of various investments throughout the quarter, below is the standard style box performance for the first quarter of 2022:

 

Style / Market Cap Value Blend Growth
Large Cap -0.74% -5.14% -9.02%
Mid Cap -1.87% -5.73% -12.68%
Small Cap -2.49% -7.54% -12.65%

 

The style box performance for the first quarter of 2022 showed a wide divide between the different styles and market caps during the quarter. Value was the clear winner across all three market cap sizes as large cap value turned in the best performance with investors moving toward companies in that style box for their dividends and perceived safety in the now rising rate environment. Growth companies, typically more reliant on debt for funding operations, saw the worst performance during the quarter as rates moved significantly higher. When looking at size, the smaller the companies, the more they struggled during the quarter, regardless of the style they fall into. The long-standing deviation in performance between small caps and large caps early in the quarter looked as if we may finally see a flip with small caps outperforming for the first time in several years, but this was not to be the case by the end of the quarter.

 

The following table gives the performances of the best sectors for the first quarter of 2022:

 

Sector Change
Oil & Gas Exploration 38.62%
Energy 37.03%
Natural Resources 29.20%
Insurance 9.54%
Aerospace & Defense 7.95%

The best performing sectors during the quarter were largely driven by two things, the war between Russia and Ukraine or rising interest rates. The war in Ukraine was the primary driver in the spike in oil prices around the world during the second half of the quarter. With oil prices up more than 35 percent during the quarter, it was not surprising to see Oil & Gas Exploration and Energy overall take the top two spots when looking at sector performance. Natural Resources, largely made up of oil but also many other commodities, followed suit, posting a gain of near 30 percent. Insurance came in fourth for the quarter as the sector historically has done well in a rising interest rate environment. High interest rates historically have meant that insurance companies can offer more attractive products to consumers. Rounding out the top performing sectors for the quarter was the Aerospace and Defense sector, which benefited from the fighting in Ukraine as foreign countries sent billions of dollars’ worth of weapons and equipment to Ukraine during the quarter.

 

The bottom-performing sectors for the first quarter of 2022 were as follows:

 

Sector Change
Consumer Discretionary -12.81%
Software -13.26%
Biotechnology -14.55%
Semiconductors -15.48%
Home Construction -28.36%

 

Home Construction took the bottom performing spot for the quarter as mortgage rates jumped higher along with other interest rates. A shortage of building materials such a lumber for framing and finishing items such as appliances, cabinet doors and windows also added pressure to the sector which was experiencing labor shortages at the same time. Semiconductors came in second from the bottom for the quarter as demand continued to outpace supply for the sector as a whole and production was hit during the quarter by fresh COVID-19 lockdowns in some countries. Biotechnology struggled during the first quarter as the sector appeared to have a strong inverse correlation to interest rates. Software was in the same boat during the quarter, with the added pressure of the Metaverse moving more to the front and center and the realization of a large amount of money needing to be spent by software companies to stay relevant in Web 3.0. Consumer Discretionary rounded out the bottom performing sectors during the quarter as the sector struggled with high rates of inflation and waning consumer confidence.

Commodities were all higher during the first quarter of 2022, with Oil and Grains booking some of the largest gains. Returns were as follows:

 

Commodity Change Commodity Change
Goldman Commodity 32.38% Oil 36.35%
Gold 5.67% Livestock 5.65%
Silver 6.37% Grains 24.35%
Copper 5.91% Agriculture 10.78%

 

Overall, the Goldman Sachs Commodity Index (a production weighted index) gained 32.38 percent during the quarter, as Oil increased 36.35 percent. The war in Ukraine, followed by sanctions on Russian oil, OPEC refusing to raise output and increasing global demand for oil all played a role in the spike high in oil prices during the quarter. All of the major traded metals gained ground during the quarter with the precious metals’ gains about the same amount as the more industrially used metals. Some of the rarer earth metals during the quarter spiked to multiyear highs as exports from Russia, which is a signficant player in many of these smaller metal markets, were hit with sanctions. Soft commodities were strong, with Agriculture posting a gain of 10.78 percent while Grains jumped by 24.35 percent. The jump in Grains was all due to uncertainty about the planting and harvest that will come out of Ukraine this year as fighting spilled into the planting season and the region produces a significant amount of globally traded grains and fertilizers. Livestock advanced 5.65 percent, as inflation hit the meat producers in the U.S. in the form of higher feed costs.

 

Fixed income markets in the U.S. had one of the worst quarters that we have seen in many years as the U.S. Federal Reserve finally achieved its goal of liftoff in rates with a quarter point rate hike at the March FOMC meeting. As is normally the case, the long end of the yield curve saw the most impact with some bonds falling in value by more than 11 percent. The shorter maturity bonds during the quarter, while also adversely impacted, were much less so. TIPS during the quarter posted a loss despite the very large inflation kicker in the bonds as the value of the bonds fell by more than the inflation adjustment. We have now entered what could be a very difficult time for fixed income investors for several more quarters, if not years, to come as the Fed continues to raise rates at a faster than typical rate. We ended the first quarter with a clear warning sign from the fixed income markets as we were either inverted or very close to being inverted along several different trading pairs of the yield curve. Yield curve inversions have been a sign of a looming recession for many years and this time doesn’t appear to be any different.

 

Fixed Income Change
Long (20+ years) -10.63%
Middle (7-10 years) -6.37%
Short (less than 1 year) -0.15%
TIPS -3.07%

 

For a PDF version of the below commentary please click here Weekly Letter 4-4-2022

Callahan Capital Management

Weekly Commentary | April 4th, 2022

Major Theme of the Markets Last Week: Peace or No Peace?

Despite the trading week last week containing the final trading days of the first quarter of 2022, the financial markets remained intent on watching the developments in Ukraine. Early last week, it became clear that Russia was having a difficult time trying to push into Kyiv as the resupply lines had been attacked numerous times and the Russian columns of troops and machinery were running low on food and fuel. On Tuesday, news emerged that talks between Ukraine and Russia went well, according to the media, with Russia saying it would cease attacking Kyiv. This pushed the U.S. and global markets higher as there was hope that the fighting may soon end. On Wednesday, the U.S. markets snapped a multiple day winning streak as Russian officials said there was nothing productive that came out of the recent negotiation meetings. However, Russia started to pull back troops around Kyiv as Russia needs more troops in eastern Ukraine to attempt to fully secure the Donbas region. While the situation remains fluid, at least for now, it looks like the Russian military has incurred significant setbacks and is withdrawing to regroup and figure out what the next best steps will be. President Zelenskyy warned that Ukrainian forces are preparing for further attacks on the Kyiv region as well as sending troops toward the eastern front. This comes at the same time that western intelligence agencies were reporting that Russian President Putin probably has no idea how badly things are going in Ukraine for Russia, as his closest advisers and military leaders wouldn’t dare tell him the bad news. Western media pointed out that this lack of knowledge about what is really happening in Ukraine could prove a problem in negotiations between the two sides as the ultimate decision maker, Russian president Putin, doesn’t know that he is essentially playing from a weak hand, thinking instead that he has a very strong hand. The trading week ended with no real resolution to the situation in Ukraine, and the outcome remains uncertain.

Late in the week, Russian President Putin signed a decree that states that all foreign buyers of Russian natural gas must pay for their gas in rubles. The EU and its member countries were quick to say that they would not be paying in rubles and would continue to make payments in Euros. President Putin initially said the change would occur on April 1st. Some financial institutions in Russia have set up business operations to help facilitate the transfer of one currency into another should payment in Rubles actually be needed, but most economists and commodity traders remain skeptical.

Europe is starting to come to the realization that the war in Ukraine, while not a member of the EU or NATO, is starting to adversely impact their economies. Last week, ECB President Christine Lagarde released adverse economic scenario projections which showed the ECB’s expected Eurozone growth to shrink to just 2.5 percent in 2022 from the base case of 3.7 percent. Reasons for the decline in the scenario included energy supply issues, more sanctions from both sides and greater geopolitical uncertainty. For any companies operating in Eastern Europe or Russia, it will be difficult to say with any certainty what they think about the future for their business operations in the region. This could have spillover effects on the rest of the global financial markets as well.

Financial News Impacting the Markets

The financial media was all abuzz last week about the U.S. yield curve and the potential for an inversion of the 10-year treasuries and the 2-year treasuries. At the start of the week, there was about a 10-basis point spread between the two, but on Tuesday we briefly saw an inversion occur for only about two minutes of trading in which the 2-year treasury yielded more than the 10-year. Economists in the media took both sides of the fight with some saying that an intraday inversion that was so quick should not count while others say it is a sure sign of a recession to follow. Later in the week, part of the argument was cleared up as we saw a full inversion and it stayed through the close and through the follow day of trading. We have a yield curve inversion; so what? The yield curve inversion is an old signal that a recession is coming. The problem is that there is no regularity as to the length of time before the recession starts and what happens between when the inversion occurs and the recession starts, in terms of market performance. The table below from FactSet shows the past 6 inversions that have occurred between the 10’s and 2’s and the amount of time before the recession and the equity market returns.

As you can see, the length of time to a recession ranges from 6.3 months (most recent inversion) to almost 2 years with returns during that time ranging from -18.7 percent to a gain of 28.6 percent. With everyone knowing that a recession is coming, confirmed by the yield curve inversion, when looking objectively at the data, there is almost nothing else that can be gleaned from the development. It is an intriguing situation for the Fed, however, as it is at the start of what could be a lengthy rate hiking cycle, which was also in the news yet again last week.

Federal Reserve officials last week continued to say they were going to be data dependent as to when they will be raising rates and by how much they will be moving. The economic data last week seemed to give mixed signals, however, as happens frequently. The Core PCE inflation index for the month of February posted the highest annual rate since 1983 on Thursday with a reading of 5.4 percent, but this reading excluded both food and fuel. When food and fuel were included, the PCE inflation rate was 6.4 percent through February. The problem is that in February we had not seen the impact on food and fuel, which have been jumping higher in almost all parts of the U.S. as a result of the War in Ukraine. We could easily see a print on the March PCE numbers north of 8 percent, which could force the Fed to act with a 0.50% hike at the next FOMC meeting. On Friday, the Employment data for March was released with fewer than expected nonfarm payroll jobs being reported while at the same time the labor force participation rate increased, and the unemployment rate unexpectedly dropped by 0.2 percent down to 3.6 percent. The 50-year low level for the unemployment rate in the U.S. is just 3.5 percent so we are right on the cusp of it at this point. The positive jobs data last week doesn’t seem like it would have dissuaded the Fed from its current thinking or plan of action.

Oil was the final bit of financial news that made a lot of headlines last week as we saw prices fall from their recent highs. Some of the decline in the price of oil came early last week as rumors swirled that President Biden would be releasing oil from the Strategic Petroleum Reserve (SPR). A large piece of the decline came on Friday when the rumors were proven true as President Biden announced that he would be releasing 1 million barrels per day from the SPR for the next 6 months to help combat the high costs of gasoline and other fuels here in the U.S. If the full 180 million barrels of oil are released, it will easily be the most oil released from the SPR ever. Several other countries have also joined in on the oil release from other reserves, which ultimately pushed oil prices down at the end of the week with WTI crude oil falling nearly 13 percent at one point and closing the week below $100 per barrel. The high oil prices, while bad for most sectors, is good news for the Energy sector, which accounts for nearly all of the positive revisions to earnings expectations that we have seen over the past month.

Market Statistics

 

  • Equities:S. equity markets were mixed last week as investors attempted to make sense of the current market situation as we closed out the first quarter of 2022. The biggest market movements came around the end of the quarter and the announcement that Russia was pulling back from Kiev, which it looks to be doing. Investors tepidly moved back into large cap technology last week which had been performing the best prior to the latest run of inflation and the War in Ukraine. The move, while done on high trading volume, had the feel of being cautious through the week. The Dow was the only major U.S. index to post a decline, thanks to signficnat declines in Intel, Walgreens, JP Morgan and Chevron, all of which declined by more than 3 percent.
  • NASDAQ (0.65%) – Above Average volume
  • Russell 2000 (0.63%) – Above Average volume
  • S&P 500 (0.06%) – Above Average volume
  • Dow (-0.12%) – Above Average volume
  • Sector Performance: Last week, much of the sector movement seemed to be related to the retreat in bond yields that we saw last week. Sectors of the markets that do well in falling rate environments did well last week and the opposite also held true. Real Estate is perhaps the most interest rate sensitive sector and with rates declining last week, the sector moved higher for the week. The same can be said for Utilities, Biotechnology and Medical Devices as all three benefitted from the decline in rates even if the decline is only temporary. Rounding out the top five performing sectors last week was the consumer staples sector, which is a bit of a defensive sector, but one that had been underperforming recently and benefitted from earnings releases from a few key companies.

Sectors that underperformed last week included financials, Broker Dealer and Regional banks all of which are sectors that do very well in a rising rate environment and poorly in a falling one. Railroads and ground transportation had a difficult week last week and brought the Transportation sector into the bottom performing sectors list but there did not appear to be a clear reason. Semiconductors rounded out the bottom performing sectors last week as Intel released its first Arc GPUs last week. The Arc GPU (Graphic Processing Unit) are a new line of GPUs that use AI-based upscaling technology much like what other chip makers have released recently. The release by Intel last week left investors feeling like Intel is behind the curve and they subsequently sold, pushing Intel down by more than 7 percent for the week.

  • Top Sectors: Real Estate, Utilities, Biotechnology, Medical Devices, Consumer Staples
  • Bottom Sectors: Financials, Broker Dealers, Transportation, Semiconductors, Regional Banks
  • Commodities: Rarely do we see a week in the commodities markets where the commodity moves almost exactly the same amount, only the opposite direction as the previous week. Last week was one of those rare such weeks. The Goldman Sachs Commodity Index (a production weighted index) dropped by 7.26 percent for the week as Oil moved lower by 8.14 percent. Oil prices moved lower following President Biden releasing the most oil from the Strategic Petroleum Reserve (SPR) over the coming 180 days, 1 million barrels per day, as discussed in greater detail above. Metals were mixed last week as investors around the world moved back out of precious metals with Gold and Silver declining 1.58 and 3.15 percent, respectively, for the week while the more industrially used Copper advanced 0.64 percent. Soft commodities were all lower last week with Agriculture posting a loss of 2.29 percent for the week as Grains moved lower by 6.64 percent and Livestock posted a loss of 2.97 percent.
  • GS Commodity Index (-7.26%)
  • Oil (-8.14%)
  • Livestock (-2.97%)
  • Grains (-6.64%)
  • Agriculture (-2.29%)
  • Gold (-1.58%)
  • Silver (-3.15%)
  • Copper (0.64%)
  • International Performance: Global index performance was highly positive last week with 81 percent of the global indexes moving higher, while 19 percent declined. The average return of the global indexes last week was 1.02 percent. When looking at the global index performances for the previous week, the best performing indexes were in Eastern Europe and the Nordic region. When looking for regions that struggled last week, there were no clear trends in the 18 indexes globally that posted losses for the week. The most notable indexes to decline last week were in Japan and Taiwan. Russian financial markets opened back up last week, but only to Russian investors and it is unclear how much the Russian government helped behind the scenes to ensure Russia’s equity markets moved higher for the week. Foreign investors in Russia remain frozen currently.

 

  • Best performance: Russia’s RTS Index (24.58%)
  • Worst performance: Sri Lanka’s Colombo All Share index (-18.97%)
  • Average: (1.02%)
  • Volatility: The VIX had an unremarkable week last week, posting the narrowest trading range for a week that we have seen since the week of January 14th, 2022. It could have been the general lack of surprising information released last week or the fact that Russia now looks to be pulling back from Kiev, but for whatever reason, investors were calm when thinking about the next 30 days for the U.S. markets. For the week, the VIX posted a decline of 5.67 percent down to 19.63. This is also the first weekly close for the VIX below 20 and also since the week of January 14th. A reading of 19.63 implies a move of 5.67 percent over the next 30 days for the S&P 500. As always, the direction of the movement is unknown. The fall in the VIX has been very impressive given the fact that earlier in March the VIX was as high as 37, having now fallen a little less than 50 percent.

Model Performance and Update

For the trading week ending on 4/1/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model 0.43% -5.04% 5.46%
Aggressive Benchmark 0.39% -5.00% 7.36%
Growth Model 0.64% -3.37% 4.79%
Growth Benchmark 0.32% -3.83% 6.01%
Moderate Model 0.83% -1.55% 4.12%
Moderate Benchmark 0.23% -2.68% 4.57%
Income Model 1.03% -0.54% 3.93%
Income Benchmark 0.12% -1.27% 2.67%
Quant Model -1.24% -9.43%
S&P 500 0.06% -4.62% 12.41%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

There were no changes in the hybrid models over the course of the previous week, but there was another quarter earnings report from a core equity position. McCormick & Company (MKC) reported its first quarter 2022 earnings last week and beat expectations on both the top and bottom line. The company operates primarily in two different segments: consumer and flavor solutions. Consumer sales were down about 2 percent as consumers returned to eating out more frequently. Flavor solutions, however, saw its sales increase 14 percent on a constant currency basis as demand for away-from-home products continued to recover. The company called out inflationary pressures on the analyst call but did not sound concerned about the current amount of inflation the business is experiencing as the company can deal with the cost through both cost savings initiatives and pricing actions. MKC’s acquisition of FONA International at the very end of 2020 has now been fully rolled into the MKC business and has been adding steadily to MKC’s top and bottom lines while helping to grow MKC’s global footprint in the flavor solutions segment. There are no core equity positions scheduled to report earnings this coming week, but we do get fully underway the following week with earnings reports for the first quarter 2022 earnings season.

Looking to the Future

  • Earnings: Earnings season is only a week away!
  • Russia: Fall back and regroup for new attacks or move on?

Interesting Fact: Where Did April Fools’ Day Come From?

The exact origin of April Fools’ Day remains unknown, but historians came up with several theories of how the day started.

Some believe that it originated in Ancient Rome as the festival of Hilaria – ‘joyful’ in Latin – to mark the beginning of the spring, which was known for games and mockery.

Other historians believe that it began when many refused to accept the change of New Year’s Day from March 25 to Jan. 1, as Pope Gregory XIII ordered Christian countries to switch from the Julian calendar to the Gregorian calendar in 1582. Those who still celebrated the new year in April were called “April Fools” and made fun of by people who celebrated the new calendar, according to the theory. The pranks pulled on them included putting paper fish on their backs, symbolizing easily caught fish and a gullible person.

Source: http://www.nbcchicago.com

Have a great week!

Peter Johnson

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

For a PDF version of the below commentary please click here Weekly Letter 3-28-2022

Callahan Capital Management

Weekly Commentary | March 28th, 2022

 

Major Theme of the Markets Last Week: Potential Rate Hike Slam-Dunk on Markets

Markets were set for a slow week last week as we are in between earnings seasons, FOMC meetings, political decisions and winter and summer. With so many items that typically prove a catalyst for market movements being absent, investors focused more than usual on economic data releases as well as statements made by Federal Reserve officials. Monday was all about what Fed officials were saying. Early in the day, Atlanta Fed President Bostic, a notable hawk on the Fed, released a dovish statement. In the statement, he pointed to high levels of uncertainty in many aspects of the U.S. economy when he said that he is less confident in the extremely aggressive rate tightening path that he had been on previously. This relatively dovish shift had some investors concerned that they may be missing something that the Fed is seeing in the data as it pertains to the near-term movements of the U.S. economy. The dovishness of President Bostic was somewhat short lived as Fed Chair Powell, in an address to the National Association of Business Economics, said that the Fed could be in a position to increase rates by 0.5 percent at a meeting in the future, should the data warrant such a move to combat inflation. This is essentially what Chair Powell has been saying now for more than two weeks, but it still seemed to catch investors off-guard that two Fed officials would be saying things so differently when looking at essentially the same data.

 

The fear remains that the Fed is very late to the party and that rates have been far too low for too long. With inflation now running rampant in the U.S. economy, the Fed must take action to fulfill its price stability mandate. The action it is taking is to raise interest rates, through the Fed funds rate. However, the raising of the Fed funds rate and the reaction of the fixed income market and inflation is not an exact science. If the Fed raises rates too quickly, it runs the risk of overcooling the economy and pushing the U.S. economy into a recession. This has occurred a few times in the past, but normally when the Fed surprises the markets with a big hike in rates. If the Fed does nothing or moves too slowly, inflation will keep increasing, eventually causing demand destruction from consumers, which can also lead to a recession. The Fed must walk a very fine line between the two extremes. One difference between this time and times in the past, when rates were being increased, is the amount of open discussion and telegraphing that the Fed does ahead of moving rates. So far, Chair Powell has been very explicit about when rates will be changing, which takes some of the shock out of the moves when they do occur.

 

The fixed income market here in the U.S. last week had several trouble signals in terms of yield curve inversions last week that are typically omens of a recession. A yield inversion occurs when a short-term bond has a higher yield than a longer dated bond. Last week, I mentioned that the yield curve looked like it was inverting during the day on Monday, and it did in fact see several pairs invert. During the week last week, we saw the yields on the 7-, 5- and 3-year bonds all yield more than the 10-year bond. The 2-year remained stubbornly below the 10-year yield. Part of this was due to the gigantic move in yield that we saw on the 10-year as we saw more than thirty basis points of movement with the 10-year closing above 2.5 percent for the first time since 2019. The two tens spread is the “official recession warning,” and while it remains yet to invert, investors are concerned about it. It is only a matter of time. Already this year, many fixed income investments have struggled with investors seeing losses of more than 5 and 10 percent to start 2022, despite the thought that bonds are safer than stocks (this is typically the case in a long falling rate environment). This time in this rising rate cycle could be very different for fixed income investors.

 

Financial News Impacting the Markets

Oil made headlines last week as Brent Crude oil briefly moved over $120 per barrel on various analyst predictions at the Financial Times’ Commodities Global Summit held in Lausanne, Switzerland last week. Some of the top oil analysts from around the world gathered at the event and prognosticated their views about the future movements of oil prices. Pierre Andurand, a well-known hedge fund manager and oil trader, predicted that Russian oil will be shunned by Europe as soon as they are able and they would be moving away from Russian oil this year. He predicted that Brent crude oil could hit as high as $250 per barrel as more than three million barrels per day of Russian oil are removed from the global markets. Many of the analysts and managers at the conference had price targets between $200 and $250 per barrel for Brent crude by the end of 2022. This sent the price of Brent crude up to more than $122 per barrel. However, the move about $120 was short lived as a meeting between EU and NATO leaders last week concluded with the announcement that no sanctions would be put on Russian oil being imported into Europe at the current time. Europe desperately wants to be off Russian oil and natural gas but at the current time it would bee too costly for them to turn off the flow. The major issue for the energy market around the world will be where the supply comes from to make up the newly lost Russian barrels of oil. Production would need to ramp up in Europe, the Nordic region and in countries such as Azerbaijan, but this would take time. According to the Financial Times, it takes between 12 and 18 months to meaningfully increase production from many of these countries and regions, meaning the current price spike in the price of oil will potentially get worse before it gets better and that it is going to be higher for a lot longer than most people initially thought.

Home Builders had a horrible week last week, posting one of the worst weeks for the group in several years. While the demand for housing has been strong, we are starting to see cracks in the U.S. housing market in the economic data. Last week, KB Homes released its most recent quarterly earnings and missed expectations on both the top and bottom lines as the company struggled with home deliveries during the quarter despite higher home prices. Home deliveries (completions) are becoming more difficult for the major builders around the U.S. as the companies deal with shortages of items such as cabinet doors, appliances, windows, siding and even framing materials such as lumber. Labor is also starting to become a problem for the home builders as many alternative jobs are now paying higher wages, attracting some home construction workers. The economic news last week saw new home sales for February decline by 2 percent while pending home sales for February declined by 4.1 percent, marking the fourth monthly decline in pending home sales in a row. One of the major factors in the declines is mortgage rates as they jumped higher last week and ended the week with the 30-year mortgage national average at 4.5 percent, a significant move higher than the sub three percent rates that were prevalent this time last year.

 

The final piece of news last week that impacted the markets was COVID-19 and the spread that we are seeing in China. Late last week, it became clear that Omicron was quickly spreading in China. With China adhering to a zero-case policy, the country had already shut down several key manufacturing regions. Late last week, it was announced that Shanghai would be entering a lock down of sorts. The first lockdown of Shanghai is for eastern Shanghai and started today. It will run for five days, initially. Western Shanghai is set to go into a lockdown later this week with the duration also expected to be five days. However, these lock downs will potentially be expended as they allow time for government officials to test everyone in the lockdown area. Apple was one of the first major companies in the U.S. to announce that manufacturing issues in China could adversely impact its business during Q1 2022, but there are certainly more companies to follow. Oil and other commodities that China uses heavily in its manufacturing economy moved lower over the weekend and into Monday as fears of a more widespread shutdown grew.

 

 

 

Market Statistics

 

  • Equities: Equity markets moved mostly higher last week with only the small cap Russell 2000 lagging and posting a decline. Volume was average on all four of the major U.S. indexes as it was a slow feeling week for many market participants. Despite the second week of gains for most of the indexes, the equity markets in the U.S. are still well off the levels at which they started 2021.

 

  • NASDAQ (1.98%) – Average volume
  • S&P 500 (1.79%) – Average volume
  • Dow (0.31%) – Average volume
  • Russell 2000 (-0.39%) – Average volume

 

  • Sector Performance: Rumors of Brent crude oil potentially moving over $150 per barrel in the future, as Europe weans itself off of Russian oil, helped send the price of Oil higher by more than 8 percent last week. Moving right along with the price of Oil was the Oil and Gas Exploration sector as well as Energy overall, Natural Resources and Basic Materials, which made up four of the top five performing sectors last week. Rounding out the top five performing sectors last week was the Insurance sector, which benefited from the rising interest rate environment.

 

When looking at sectors of the markets that underperformed last week, it was primarily sectors that are negatively impacted by rising interest rates. Home Construction made the bottom of the list last week as poor earnings results from KB Homes combined with slower home sales and rising rates on mortgages. Biotechnology, Medical Devices and Software took three of the bottom five sectors last week as each sector dealt with rising operational costs due to the rising cost of issuing debt, which is vital to many of their operations. Financial Brokers Dealers took the final spot when looking at the bottom five performing sectors last week as the sector was adversely impacted by the yield curve inversions that occurred during the week, signaling that a recession could be in the near future for the U.S. economy.

 

  • Top Sectors: Oil & Gas Exploration, Energy, Natural Resources, Basic Materials, Insurance
  • Bottom Sectors: Software, Broker Dealers, Medical Devices, Biotechnology, Home Construction

 

  • Commodities: The relative calm in the commodity markets lasted only one week as the volatility came back with near full force last week. The Goldman Sachs Commodity Index (a production weighted index) jumped by 7.4 percent for the week as Oil moved higher by 8.17 percent. Much of the movement in oil came around speculation that the price of Brent crude oil would reach near $150 per barrel over time if Europe were to work itself off of Russian oil in the future. Oil prices were higher during the week than where they ended, as news that Europe would not be blocking the importation of any Russia oil for the time being helped alleviate some of the oil fears. Metals were mixed last week as investors around the world moved back into precious metals with Gold and Silver advancing 1.72 and 2.00 percent, respectively, for the week while the more industrially used Copper declined 0.68 percent on fears that further shutdowns in China may hinder future demand for the industrially used metal. Soft commodities were all higher last week with Agriculture posting a gain of 2.87 percent for the week as Grains moved higher by 2.33 percent and Livestock posted a gain of 3.67 percent.

 

  • GS Commodity Index (7.40%)
  • Oil (8.17%)
  • Livestock (3.67%)
  • Grains (2.33%)
  • Agriculture (2.87%)
  • Gold (1.72%)
  • Silver (2.00%)
  • Copper (-0.68%)

 

  • International Performance: Global index performance was split last week with 56 percent of the global indexes moving higher, while 44 percent declined. The average return of the global indexes last week was 0.26 percent. When looking at the global index performances for the previous week, the best performing indexes were in South America and the USA as both regions posted solid gains. Asia, the Nordic region, and Europe turned in the worst performance, from a regional basis, last week. Russian financial markets opened last week, but it is a new system, with foreign investors trading in one market and local Russians trading in another. The Russian RTS Index started trading with moving higher but ultimately gave up ground by the end of the week.

 

  • Best performance: Mongolia’s MSE Top 20 Index (5.45%)
  • Worst performance: Russia’s RTS Index (-11.45%)
  • Average: (0.26%)

 

  • Volatility: The VIX had a very uneventful week last week, moving in a slowly downward sloping path through much of the week. By the end of the week, the VIX had posted a decline of 12.82 percent, ending the week under 21 for the first time since January 14th. The VIX hitting such a low level at this time of the year seems to indicate that while there may be dark clouds on the horizon, investors are not very fearful that they will amount to much of anything that could derail the markets over the next 30 days. We are more than 30 days from the next FOMC meeting and more than 30 days away from the majority of first quarter 2022 earnings, two of the significant wildcards that are on the horizon. With a reading of 20.81 on the VIX, the fear gauge is implying a move of 6.01 percent for the S&P 500 over the next 30 days. As always, the direction of the movement is unknown.

Model Performance and Update

 

For the trading week ending on 3/25/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week YTD 2022 Since 6/30/2015

(Annualized)

Aggressive Model 0.70% -5.45% 5.41%
Aggressive Benchmark 1.04% -5.37% 7.32%
Growth Model 0.62% -3.98% 4.71%
Growth Benchmark 0.82% -4.13% 5.98%
Moderate Model 0.55% -2.36% 4.00%
Moderate Benchmark 0.58% -2.90% 4.55%
Income Model 0.54% -1.56% 3.78%
Income Benchmark 0.30% -1.38% 2.66%
Quant Model 3.13% -8.28%
S&P 500 1.79% -4.68% 12.44%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week. The upcoming earnings season could be a very interesting one for the core equity positions in the models as each company has had to deal with Omicron as well as the situation in Russia and Ukraine differently. McDonalds, Coca-Cola, Teledyne and McCormick are the holdings which could see the largest direct impact of the Russian situation. Companies such as Republic Service group, Wal-Mart, Gallagher and Canadian National Railway should see little, if any, impact from the situation in Ukraine. Earnings expectations have been moving lower over the past few weeks so we could be in for an earnings season with low bars set everywhere and many companies easily jumping over the bar. The real information this earnings season will be in management’s projections for the future.

 

Nike announced its most recent quarterly results last Monday as the company does not follow a standard year quarterly calendar. For the company’s most recent quarter, Nike beat both earnings and revenue expectations as stronger than expected sales in North America more than offset the production slowdown in Asia and slowing demand in China due to COVID-19. Sport and casual attire continue to show strong growth as return-to-office, when it is happening, is permitting more casual clothing in many cases. One new product that Nike is very excited about, that is coming out in the next few months here in the U.S., is a shoe that is put together with no glue, as the pieces of the shoe interlock. The new shoe requires significantly less raw materials to make and is made in a fraction of the time of a normal shoe. The strong results by Nike saw the company jump by nearly 5 percent following the announcement.

 

Looking to the Future

 

  • Earnings: Earnings season is about to start, and estimates are coming down
  • Russia: Very uncertain as to how the situation in Ukraine will play out
  • Inflation data: PCE data is released on Thursday

Interesting Fact: A Group of Bunnies Is Called a “Fluffle”

A group of bunnies is called a fluffle; baby bunnies are called kittens; and, when a rabbit jumps and squirms in the air, that move is called a binky. That means, at kaninhoppning events—a popular competition in Sweden about rabbit jumping—you could find a fluffle of bunnies and kittens working on their binky skills. Have you ever heard a more aww-worthy sentence?

 

Source Nowiknow.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.