It’s a Mad, Mad, Mad, Mad World
Our title this week is also the title of a 1963 comedy. The movie is about a group of motorists that witness a deadly accident. The drivers’ final words are the location of a hidden stash of money. The situation quickly devolves into a wild and hilarious free for all to find the money first. It’s no coincidence this old movie popped into our mind this week as markets started intensely chasing money once again.
The AI Craze
Artificial Intelligence is the ‘next big thing’ and Wall Street always loves the next big thing, so AI stocks took off late in the week, with NVIDIA leading the way as they blew away quarterly revenue and projected much greater chip demand through the remainder of the year. The earnings report pushed NVIDIA stock up 24% on Thursday alone!
In a LinkedIn post, New Constructs, a provider of analytical tools, estimated that to justify NVIDIA’s current price (using a discounted cash flow analysis), NVIDIA would have to grow revenue at a 20% rate for the next 19 years, improve their operating profit after tax from 27% to 44% and improve the return on capital from 34% to 778%. The money chase is on; welcome to the next bubble. The only question that remains is how large the bubble gets before it pops. We would guess we are still in the early stages, but there are plenty of pins out there too.
The Debt Ceiling
Congress’ search for money continues as the debt ceiling issue remains. The week began on a sour note as the hoped for weekend deal did not materialize, and with time running out, the threat of a default drew closer and markets weakened. As we have been saying, a debt ceiling deal is preordained to come right down to the wire and possibly a bit past the wire. It is the only way the extreme positions in Congress can be satiated, but ultimately, everybody will be paid. In the meantime, market agita will come and go, along with the changing headlines, so expect volatility until this is settled. The estimated X-date (when the money runs dry) is now June 5, and Congress will need a few days to pass legislation for any deal.
A recession is the fly in the ointment of a new bull run in the stock market. The FOMC (Fed Open Market Committee) continues to forecast a ‘mild recession’ in the second half of this year, and evidence of that development continues to accumulate. The Index of Leading Economic Indicators in April was down for the 13th consecutive month and continues to signal a recession in the near future.
The corollary to the recession is the state of the consumer, who accounts for about 70% of GDP and therefore dictates the direction of the U.S. economy. The reason we are probably not in a recession already is that the consumer is still spending. There are lots of potential reasons for the consumer to continue spending in the face of a weakening manufacturing economy, but our view has been simple. If people are still working, they will continue spending. Nonetheless, earnings reports from Target and Walmart this week were clear yellow flags.
Target Comments: The fear of a looming recession weighs heavily on many American families…total sales were strongest in February, began decelerating in March, and softened further near the end of April.
Walmart Comments: After a strong start, sales growth moderated as the quarter progressed.
With growth in credit card debt finally starting to falter, the consumer may simply be tapped out.
Unemployment claims, both initial claims and continuing claims, remain at very low levels. Both were rising through the first quarter, but have leveled off recently (see chart below). Is this suggesting that a recession might be avoided after all?
Core PCE inflation, (the Fed’s choice for measuring inflation) rose slightly in April at +0.4% month over month, vs. +0.3% expectations. PCE Services Inflation, ex-housing, which has been mentioned by Chair Powell as the segment that needs to come down, refuses to cooperate and was up 4.64% from 1 year ago. One month does not a trend make, but to be clear, this is not the data the Fed was hoping for and it raises the possibility of more rate increases this summer.
Welcome to the club. We are still correcting from COVID slamming the brakes on the economy, which was quickly followed by a fiscal push that was like an alcohol fueled dragster pulling the economy forward. The economic whiplash continues. We can draw parallels to other periods but this is simply unlike anything anyone alive has ever witnessed.
We still believe that the preponderance of evidence suggests that the economic whiplash will continue a while longer as we head into a recession, but whatever happens, owning quality companies reinvesting earnings at high rates of return will perform much better over time than trying to trade hot stocks as if they were in a fantasy investment league.
What We’re Reading
Slimmed-down U.S. debt ceiling deal takes shape (Late Friday)
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