Not as Bad as It Feels
Doug Walters
Declining markets are never fun. The S&P 500 is down over 13% on the year. That is officially in “correction” territory, which is loosely defined as a drop of 10% or more. But it is not as bad as it feels, or at least it should not be.
Contributed by Doug Walters , Max Berkovich , David Lemire
Declining markets are never fun. The S&P 500 is down over 13% on the year. That is officially in “correction” territory, which is loosely defined as a drop of 10% or more. But it is not as bad as it feels, or at least it should not be.
Investors have become accustomed to market leadership by mega-cap tech and communications companies. We have given them many acronyms, the most famous of which is arguably FAANG stocks. Not only are they highly visible in the press (and our lives), but they represent a significant portion of many common market-cap-weighted indexes, given their enormous size. While they were performing well, investors benefited from that size, but as we watch them decline, many investors feel the pain.
Since the start of the year, the original FAANG stocks are down an average of 35%, with Netflix the worst, falling 67%. We have an easy way of visualizing the negative impact of these influential stocks on index performance. While the S&P 500 is down around 12% on the year, the “equal-weighted” S&P 500 is down only 8%. The equal-weighted index holds an equal amount of each of the 500 companies in the index rather than weighting the holdings by market cap. This behavior is what we call, in the factor speak, the “Size” factor. Historically, equal-weighted indexes tend to outperform market-cap-weighted indexes.
So why do so many investors prefer to hold market-cap-weighted indexes? Good question. In our opinion, market-cap weighting is fairly arbitrary. There is usually a better way to construct your portfolio when you follow an evidence-based approach.
Headline of the Week
Stocks ended down again this week. Whispers of the potential for a 75bps hike from the Fed created some unease. Meanwhile, the first-quarter earnings season for corporations continues. More than half in the S&P 500 have reported, with over 70% beating expectations. Q1 has demonstrated solid growth in sales, but inflation has resulted in earnings growing less. Several names in big tech reported, but Apple (AAPL) and Amazon (AMZN) caught our eye.
Supply Chain Headaches
Industry heavyweights Apple and Amazon reported results this week, with a few common themes: supply chain, China and Covid.
- Apple reported results that were near record levels and well above analyst expectations. However, their outlook statements were clouded by familiar headwinds.
- The company reminded investors that the pandemic is not over and that crackdowns in China related to their “Zero Covid” policy continue to disrupt supply chains.
- Due to supply chain issues, they expect revenue to be impacted by $4-8bn in the coming quarter.
- Amazon, similarly, spent significant air time talking about the pandemic challenges facing its business.
The Fed is all-too-aware of the challenges facing companies these days. They are combatting inflation with their rate and asset purchase policies while at the same time trying not to damage growth. It is a delicate balancing act.
The Week Ahead
Interest rate moves, a Jobs report, and Earnings should move the markets next week.
Banking on It!
Federal Reserve (Fed), Bank of England (BoE), and Reserve Bank of Australia (RBA) all face rate decisions next week.
- The Bank of England is expected to continue its pace of 0.25% rate hikes, bringing the bank rate to 1%.
- A 1% Bank Rate was communicated as the level where the Central bank will start to actively sell its bond holdings, the GILT.
- Australia was previously expected to hold rates steady longer into the year. However, the 5.1% inflation rate in March may have moved the RBA to move now.
- The Fed has prepared the market for a 0.50% rate hike on Wednesday.
- A 0.25% or 0.75% move would certainly disturb the market.
- Trained eyes will focus on the balance sheet reduction commentary, with a $95 Billion a month reduction plan flagged previously by the Chair.
Labor Market
The first Friday of the month brings us a “Jobs Report.”
- The Non-Farm payroll is expected to add 400,000 jobs in April, with the unemployment rate staying steady at 3.6%
- The labor participation rate, average weekly hours, and hourly earnings will also be important.
Earning, Economics, and More…
Economic reports will take a backseat to the Fed, but Housing Starts and the Institute of Supply Management PMIs will mix in with earnings reports from Pfizer, Inc. (PFE), Starbucks Corp. (SBUX), CVS Health Corp. (CVS), Booking Holdings (BKNG) and Advanced Micro Devices Inc. (AMD) to catch investor attention.
- Earnings season starts to fade after the blockbuster week of reports this past week, but Berkshire Hathaway’s (BRKa, BRKb) annual shareholder meeting this weekend will add some excitement.
- “The Woodstock of Capitalism” in Omaha, Nebraska, will be headlined by Chairman Warren Buffet and Vice-Chair Charlie Munger discussing investing, their economic outlook, and life.
- CNBC will stream the event on Saturday, competing with the later rounds of the NFL draft.
Holidays
Cinco de Mayo is of note, and China, Japan, and Europe celebrate May Day and various other Holidays this week, with markets closed in observance in various countries. We at Strategic have a different holiday in our hearts!
- Strategic will celebrate May 4th with zeal!
- The Markets and Strategic are open, as the New York Stock Exchange does not hold Star Wars Day in as high regard as we do.
- May the Force be with you!
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