Market vs. Federal Reserve: The Battle for Control

LevelFields Weekly, Feb. 4, 2023

Tension Between Market Forces and Federal Reserve Policies

Late last week, the US Federal Reserve raised interest rates by another .25%. This was largely expected. More significant were Powell’s comments in terms of how the Fed sees the fight against inflation. Here are the highlights of Powell’s speech, paraphrased:

• We are not yet in a restrictive range
• We are in the early stages of the process
• We expect housing inflation to continue
• We have not yet seen evidence that non-housing services pricing has changed
• Ongoing rate hikes are necessary
• There is still work to do
• The job is not done
• For 56% of the economy, we have not seen any change to inflation. All the deflation has happened to less than half of the economy
• We will update the terminate rate target in March
• Core goods inflation is still at 4%
• Supply chain issues have been largely resolved
• COVID is no longer an economic threat
• We are not likely to cut rates this year

In a nutshell, the Federal Reserve is indicating that it will maintain higher rates for a longer duration than the market anticipated, citing the risks of underreacting to inflation.

While traders are presently optimistic that the Fed will cut rates this year, this expectation may change later in the year when the Fed holds its ground.

The Fed received strong support for this stance from an excellent January jobs report, which showed 276% more job creation than expected, bringing the unemployment rate to a 53-year low.

However, holding rates higher for longer can lead to a decline in earnings growth and higher costs for capital needed for expansion.

The likelihood of a market selloff and a recession is high if the Fed raises rates too fast.

Bears Get Tranqed

The market sentiment indicates that the bulls are in charge, and the bears have been suppressed for the time being, despite warnings from notable bears such as Michael Burry and Mike Wilson.

The Communications Services and Technology sectors, which were the biggest losers in 2022, performed well last week.

Additionally, there is a growing appetite for risk, as evidenced by the increase in prices for speculative assets like Bitcoin and growth tech stocks.

Conversely, safety plays such as utilities and healthcare, which performed well last year, had the worst performance last week.

All this happened while the earnings lowered for S&P 500 companies, as shown in the chart above. We’ll go into this in more detail in our Level 2 newsletter.

Revenge Trading

Do you remember the “revenge travel” trend that followed the mass COVID vaccinations? There has been so much fear in the market, and cash has been parked on the sidelines that it feels like there’s a lot of revenge trading going on.

However, the party began to fade last Friday as the reality of a steadfast Fed and a declining environment for earnings growth set in following disappointing earnings reports from Apple, Amazon, and Google.

KNOWLEDGE CORNER: WHY (DIVIDEND) SIZE MATTERS

It is difficult to know how companies are performing and what company leaders anticipate for the companies they run. The CEOs have to put on a good face when speaking about the companies they represent. And their communications team makes sure of that. So how can we determine whether a company will perform well in the future?

Dividends are one way. A company giving away its money to shareholders is typically a company with stable enough revenue in the present and forecasted future to enable it to provide capital back to its owners. If the leadership thought the company was about to take a huge hit to profits, they would not be increasing the dividend.

The bigger the dividend increase, the more confident leadership is in its cash flow situation. However, the size of the dividend before the increase matters.

A company increasing its dividend by 100% from 1 penny a share to 2 pennies a share doesn’t make much difference to an investor. But a company with a $4.00 dividend increasing it 25% means an extra dollar per share per year for every shareholder. For a holder of 1,000 shares, that’s $1,000 more a year for doing nothing but holding the stock.

In the dividend increase scenario, the biggest share price movements follow the biggest increases in the dividend amount. And over the longer term, these companies raising dividends by large amounts tend to perform well. A look back at energy companies in 2021 and 2022 can easily show these patterns.

For example, ConocoPhillips (pictured above) increased its dividend in October 2020 — right as the price of oil had recovered from epic price falls and the energy sector was about to go on to have a huge bull run. Notice the event impact on the day of the announcement was not positive due to other macro events of the day, but the follow-on price action over the subsequent years was spectacular.

HIGHLIGHTS FROM LAST WEEK

Dominion Dominates

Old Dominion Freight (ODFL) had an outstanding fourth quarter of 2022, posting record revenue and profit, which led to a 33% increase in their dividend. The rail company’s stock price surged by +10.5% following this announcement.

Smoking Hot

Altria Group (MO), a seller of nicotine products, saw a 6% increase in their stock price after announcing a plan to buy back $1B worth of shares. They also projected an earnings growth of 3–6% per share in 2023.

FedEx Trims The Fat

FedEx’s stock price surged by over 4% after the announcement of a 10% reduction in management staff as a cost-cutting measure due to slowing demand. The company is targeting a total reduction of $3.7 billion in this fiscal year, which their CEO has predicted to be a “bumpy” ride.

EV Wars

Electric Vehicle manufacturer Rivian saw a 6% increase in its stock price after announcing a 6% workforce reduction to cut costs. The company has been struggling with supply chain issues and production problems since its IPO, which resulted in significant losses for those who bought at $130/share (currently trading at $19/share).

Rivian is facing tough competition in the EV market due to rising car loan costs and cost-cutting measures from rivals like Tesla and Ford. Its only saving grace is its contract with Amazon to supply EV delivery vans. Without it, the company will face a more challenging time selling its vehicles.

METAmorphosis

In a big move, the company formerly known as Facebook saw its shares surge more than +23%. This came after Zuck and the board authorized the buyback of $40 billion worth of META stock. Along with this, META announced its latest earnings results, which although missed estimates, did indicate more stable demand for advertising.

META’s stock is now up 100% from its 52-week low. This shift has led pundits to re-evaluate their stance on the company, with many saying that it is back to being focused on profits rather than chasing the Metaverse dream.

Key Earnings Announcements This Week

February 6

• Notable Earnings:
• Chegg (CHGG)
• Activision Blizzard (ATVI)
• Tyson Foods (TSN)
• ON Semiconductor (ON)

February 7

• Chipotle Mexican Grill (CMG)
• With Chipotle’s earnings on Tuesday, investors will be looking for guidance on spikes in production costs and comments on their recent push to increase hiring.
• Other Notable Earnings:
• BP (BP)
• Assurant (AIZ)
• Essex Property (ESS)
• Illumina (ILMN)
• Enphase Energy (ENPH)
• Western Union (WU)

February 8

• Disney (DIS)
• In the last quarter, the entertainment giant has stayed in the headlines. After ousting their CEO Bob Chapek and replacing him with Bob Iger, a big Q4 miss, and mass layoffs in November, investors are waiting for guidance on theme parks post-China reopening and with an increase in travel. Comments on Disney+ subscriber growth are also a major focus due to Netflix’s recent positive performance.
• It is also worth noting that Nancy Pelosi sold 10K shares of Disney at the end of December.
• Other Notable Earnings:
• Affirm (AFRM)
• CME Group (CME)
• CVS Health (CVS)
• Dominion Energy (D)
• MGM Resorts (MGM)
• O’Reilly Automotive (ORLY)

February 9

• Paypal (PYPL)
• Events surrounding Paypal in the last few months include mass layoffs to cutting costs, headwinds facing the e-commerce space, and drama over an announcement of a policy that would fine users $2500 who spread misinformation.
• Other Notable Earnings:
• AbbVie (ABBV)
• AstraZeneca (AZN)
• Cloudflare (NET)
• Duke Energy (DUK)
• Hilton (HLT)
• Kellogg (KG)
• Lyft (LYFT)

February 10

• Notable Earnings:
• Spectrum Brands (SPB)
• IQVIA (IQV)
• Enbridge (ENB)

Economic Reports:

• 2/7
• International Trade Deficit
• 2/9
• Initial Jobless Claims
• 2/10
• Federal Budget Balance

The LevelFields Team
support@levelfields.ai