Market & Macro - April 1st, 2023
Review of the market with Q1 highlights; macro including sector, commodities, housing, inflation, dollar, and rates
Market
The first quarter of 2023 ended on Friday, March 31st, 2023.
A strong January was followed by a sell off in February, only to bounce back in March. This last climb has moved decisively above both the 200-day and 50-day moving averages. This strength, coupled with higher lows in both December and March, paint a constructive technical picture.
The economy has remained resilient. Notwithstanding large layoffs in technology, the overall employment market has been strong. Inflation has stubbornly persisted, yet appears to be turning.
Two standout themes of the last few months have been the cracks in the financial system and the emergence of artificial intelligence.
Financial instability started on the edges and has slowly creeped closer to the core, accelerating significantly in March.
July 2022 - Crypto hedge fund failed (3AC)
November 2022 - Crypto exchange failed (FTX)
March 8th, 2023 - Crypto-friendly bank failed, hitting Wall St (Silvergate Bank)
March 10th, 2023 - Tech-friendly bank failed, top 20 US bank, SF area (Silicon Valley Bank)
March 12th, 2023 - Real-estate friendly bank failed, NYC area (Signature Bank)
March 14th, 2023 - Global financial institution failed (Credit Suisse)
Governments have stepped in to intervene, providing a backstop to give confidence to depositors and making fire sale deals of these banks and/or assets.
There is ongoing concern about real estate & real estate loans. It is a large industry, with significant lending requirements in which many large and regional banks participate. Rising rates affect the value of those loans and also the operator’s ability to pay them. If the loans are fixed rate, the valuation of the loan is significantly impacted. If the loans are floating rate, tenants will have a very difficult time paying the hiked rates as the Fed rate went from 0% to 5%.
On a more positive note, artificial intelligence has had breakout success. Released in late 2022, ChatGPT has popularized generative AI and effectively started the race propelling AI forward. The chatbot developed by OpenAI and other similar technology can be used for a myriad of cases including:
And much more
Microsoft invested $10 billion in OpenAI and is rapidly integrating the technology into their offerings, starting with Bing and Microsoft Office.
Google, one of the leaders in artificial intelligence, was quick to respond, releasing Bard shortly after. They are similarly quickly enhancing their Workspace offerings such as Google Docs and Gmail to include more generative AI functionality.
This is just the beginning of the AI push. Advancements will be accelerating. Some jobs will become obsolete; new jobs will be created.
There will be interesting implications to software companies, as called out by Jamin Ball.
Running AI queries comes at a much more significant cost than traditional operations. This cost will have to be either absorbed by technology companies, putting pressure on gross margins, or passed on in pricing.
As AI makes any single individual more effective, there will likely be a shifting dynamic in the seat-based vs consumption-based business models of software companies. Companies will be able to operate with fewer people with more workloads conducted by each individual. Possibly good for consumption models (ex. SNOW, DDOG, MDB), and costly for seat-based models (ex. CRM, WDAY, TEAM).
There are serious ethical concerns about the accompanying paradigm shift. Many influential technologists and subject matter experts, such as Elon Musk and Steve Wozniak, have signed an open letter requesting that all advances to AI pause for a moment and allow society to catch up.
Macro
Breaking the market’s move down by sector shows:
Technology, communications, and consumer discretionary clearly leading the pack
Financials, healthcare, energy, and utilities rounding out the bottom
Large technology companies with fortress balance sheets have benefited from the uncertainty in the financial system.
The US dollar has now retraced the majority of the push higher in 2023. Companies with international sales benefit from a weaker dollar.
Commodity prices, a strong leading indicator for inflation, are now down year-over-year. Sugar is the one exception.
Housing and rent prices, both lagging indicators, have been rather resilient thus far but may be at an inflection point.
Inflation appears to have peaked.
Treasury yields came down meaningfully, triggered by the recent instability of the financial system and supported by lower inflation expectations.
Although the Fed is setting the overnight rate to 4.75-5.00%, 2Y treasuries are trading at a 4% yield. The lower yields indicate the market doesn’t expect the 5% yield to last those 2 years.
Powell and the Fed continue to call for holding rates higher for longer – the market is not buying it.
Current market-implied probabilities show the expectation for a pause until September, with easing from then on.
Closing
There are lots of moving parts. Some seem to be easing, others escalating. Investors benefit from having a wide range of inputs and assessing all of the available information.
The market has moved up to start 2023. Unless the economy falls into a deep recession, there may be further opportunity ahead.
The following graph shows the price and earnings ratio of the S&P 500 (SPY) over time. The market price is sitting at a ratio of 18.9x, below the normal PE ratio of 19.6x around which the price has historically wavered.
While there are many ongoing concerns, there are also emerging tailwinds for equities. The market is known to climb a wall of worry.
Earning season unofficially kicks off on April 14, 2023 with large banks such as JP Morgan Chase, Wells Fargo, and Citigroup.
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Torre Financial is an independent investment advisory firm focused on emerging and established compounders.
Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
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