Markets had their fourth consecutive weekly gain and showed stunning resilience in the face of headwinds. Markets rallied very strongly and closed at the highs of the day and the VIX went to the 25 handle. The Dow is on track for its strongest monthly performance since Gerald Ford’s presidency. The great debate on the Street is whether this is yet another bear market rally or the beginning of a change in the pervasive volatility and chop that have defined 2022 so far. Our Head of Research, Tom Lee, has pointed out that the stock market can rally quite a bit from here and still not run afoul of the wealth effect the Fed is trying to achieve. Stock picking is still working, and earnings are paying, or hurting, this season more than they have in recent quarters. Our Head of Quantitative Strategy, Adam Gould, has a retail sentiment indicator based on Reddit that has flipped negative, suggesting this rally could have some room to run.
There was major weakness in the Tech Generals, yet the market not only took it in stride, but it also rallied strongly. We are entering a period of traditionally favorable seasonals. This rally seemed to come out of nowhere and under the hood, the market strength is even more impressive as there’s been major outperformance in Energy, Industrials and Financials. Even the initial responses to Tech earnings were mitigated. Amazon regained much of what it lost in after-hours trading. The company was down on weak guidance for the coming holiday quarter. Apple, which was initially sold off on a minor miss for iPhones sales, rallied furiously on Friday. The company had its biggest one-day gain since April 2020.
The Fed is meeting next week, and it seems a foregone conclusion that they will conduct their fourth consecutive 75-bps hike. However, the real focus will be on the press conference following the meeting where Fed watchers will look for any signs of a dovish pivot. The rhetoric of even the most hawkish members of the FOMC has been evolving to suggest consideration of a pause of some sort. The European Central Bank and Canadian Central Bank both gave some indications of a gentler path. Republicans are also looking on track to have a good midterm election and will likely at least capture the House.
Inflation expectations, which have been far worse for self-identified Republicans, may get a little help with the election outcome. Furthermore, bloated inventory levels at big box retailers like Walmart that serve disproportionately rural and red communities will likely spark aggressive promotions to offload inventory. The American consumer has shown resilient strength in the face of rising prices and some holiday discounts will be welcome. Consumer sentiment has been improving since June lows, and our team’s analysis of the leading data suggests that the persistently high inflation expectations that are closely watched by the Fed may come down.
The week began with major political events abroad. At the National Congress of the Chinese Communist Party, Xi Jinping retained his leadership roles for a third five-year term. China’s positive economic report was overshadowed by investor worries regarding Mr. Xi’s power consolidation, part of which involved removing free-market proponents like Premier Li Keqiang and Wang Yang from the Politburo and replacing them with Xi loyalists. If there were hopes that Xi’s more secure grip on power might make it feasible for him to walk back his zero COVID policies for the sake of China’s economy, they did not materialize this week, with new lockdowns throughout China, including parts of Wuhan and Guangzhou.
In the United Kingdom, Rishi Sunak on Tuesday officially became Britain’s third Prime Minister in two months. He ascended just a few weeks after a failed bid for the post in which he made prescient criticisms of opponent Liz Truss’s economic ideas, which ultimately toppled her from leadership. Stock markets had little reaction to the expected ascension, but gilt yields dropped sharply on Monday and Tuesday.
All three major indices climbed steadily in the first half of the week, notching gains until Wednesday, even in the face of troubling results from Microsoft and Alphabet. Disappointing results by Meta and Amazon sent the Nasdaq into a tailspin the second half of the week, though the Dow continued to climb on a growing belief that the Fed might be re-orienting in a more dovish direction, albeit gradually and with caveats. Intel was Friday’s biggest gainer on major cost cuts.
Q3 GDP numbers released on Wednesday showed economic growth at an annualized 2.6% after two consecutive quarters of contraction, with strong exports fueled by a strong dollar and constrained imports due to a post-pandemic inventory glut. However, the numbers also showed a cooling down of the housing market. We have been pointing to mounting weakness in the housing market with focus on leading data. Several other statistics released this week also show this trend: The National Association of Realtors reported that pending home sales fell by 10.2% in September MoM, far more than the 4% expected. Sales were down almost a third on a YoY basis. The CoreLogic CaseSchiller Index released Tuesday also pointed toward a cooldown, specifically a deceleration in home price increases.
S&P Global reported that its flash U.S. Composite PMI Output Index fell to 47.3 from 49.5 last month, showing a private-sector contraction. S&P Chief Business Economist Chris Williamson said, “The decline was led by a downward lurch in services activity, fueled by the rising cost of living and tightening financial conditions.”
One of the more colorful corporate takeover events in modern memory culminated this morning with a tweet from Elon Musk that said, “the bird is freed.” Remember what Lynyrd Skynyrd said though: And this bird you cannot change. We’re hoping Mr. Musk turns Twitter into a thoughtful public square, but challenges abound. There have been attempts to abandon the deal, lawsuits and countersuits, and colorful exchanges between various parties. It has been a public spectacle that captured attention but now the rubber meets the road. Mr. Musk, a self-described “free-speech absolutist,” has offered a vision that prioritizes free speech over the stringent content monitoring efforts that have riled some groups. Mr. Musk immediately fired the company’s CEO and CFO. Twitter has experienced a loss in eight of the ten last fiscal years. Like other social media companies, Twitter heavily depends on digital advertising revenue, which has suffered recently as businesses tighten their belts. As finalization of the deal approached, Mr. Musk on Thursday attempted to reassure advertisers that despite his commitment to free speech, Twitter “cannot become a free-for-all hellscape, where anything can be said with no consequences!”
However, Mr. Musk appears to have grand visions for “the bird,” as he calls his new company affectionately. He tweeted that his controversial purchase of Twitter was “an accelerant to creating X, the everything app.” The idea of a super app is usually associated with the success story of WeChat, which is a one-stop digital shop for hundreds of millions in the Chinese market. WeChat was a humble messaging app that first came to dominate the Chinese attention economy as it layered on gaming, payments, ticketing, and ride-hailing functions. Mr. Musk isn’t the only person trying to emulate this success story; it has become a quest around the Valley and other technological innovation clusters worldwide. Many consider such pursuits quixotic, but hey, landing a launched rocket was once considered quixotic too.
Firstly, the super app itself is essentially a technological product of inferior mobile phones used in China during the period of critical development. Chinese phones simply couldn’t support many apps, so these providers let third-party “mini programs” add functionality. These were added at less than half the cost of developing a separate app. The rapid consolidation was also mainly because China primarily used cash and didn’t have a comparable card network to what we have in the West. This was really the fuel for the mass adoption of super apps.
There’s much more competition in the US and European developed markets, and even more importantly, more entrenched regulatory regimes and bodies. The unregulated markets and latent consumer needs for payments allowed WeChat to quickly build functionality on its network with little competition or interference from the state. The path in our own backyard would be much more complicated and involve a lot of getting in the mud with regulators and competitors. The other thing is that core groups of US consumers appear not to really want or need a super app. Millennials, for instance, feel comfortable having many apps to manage various areas of their life as you can see below. Mr. Musk has repeatedly proved doubters wrong, though, and we’ll be watching the development of this saga closely and reporting back to you.
Markets have become very bearish in sentiment and this rally is hated by many. However, Tom Lee pointed out in our research huddle this week that if these earnings misses had happened earlier in the year, the rest of the market would likely have been down around 5%. Still, despite this improvement, risks abound and the weakness in big technology does foretell some slowing macroeconomic activity. About $400 billion was wiped off their collective market caps this week. Concerningly, areas that were thought to be more immune like the cloud were not spared. Well, that was fun. On to Fed week friends.