Stocks Higher, Markets Seem More Confident on Rates Outlook, Sainsbury's: Where are the Margins?

Stocks inched up in Europe in early trading on Wednesday after more positive session on Wall Street. The FTSE 100 regained 7,700 after snapping a 5-day win streak in the previous session. The Nasdaq led gains on Wall Street, rising 1% as tech continued to fetch a bid, whilst the S&P 500 rallied 0.7% as Jay Powell, the Fed chair, shied away from laying down too hawkish a message as he spoke at a central bank symposium in Sweden. Not a lot on the slate today – US 10yr bond auction perhaps of note. Key US CPI is tomorrow. Dollar holding lows at 103 but not making fresh lows yet. Gold continues to move up, crude oil firming a touch, copper making fresh cycle highs.  

Powell says Fed won’t be a "climate policymaker”  

“We should stick to our knitting". Fed chair Jay Powell didn’t directly address current US economic or monetary policy, leaning more on the importance of central bank independence. Unlike its European peer, the Fed is not looking to ‘green’ its bonds. In prepared remarks ahead of a symposium in Stockholm, Powell noted that “without explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals”.  

Going back to the old topic of inflation, the early 2023 data (weak ISM, slowing wage growth) seemed to support the ‘peak inflation’ narrative after the rolling over some of the headline inflation prints late last year. The worry seems to be more about growth now but if inflation peak has been fully discounted by the market there is room for a shock should it keep lingering for longer. The narrative gets tested tomorrow with the CPI inflation report.   

Markets still under-price the terminal rate at 4.75-5% vs the 5-5.25% indicated by the dot plot, whilst fed funds futures trading indicates cuts towards the end of the year – even as no Fed policymakers thinks they will cut this year. I think the market is underestimating it and we get closer to 6% than 5% by the middle of the year.  

Jamie Dimon – rates might need to hit 6%  

The JPMorgan CEO believes there’s an evens shot of US rate topping 6%. He said there is a 50% chance the Fed stops raising rates at 5%, and a 50% chance it goes to 6%. I put the odds on 6% at shorter than that. As repeatedly talked about in this column, the persistence of inflation and the resilience of the labour market will see the Fed squeeze rates higher than the market currently expects.  But markets seem to be buying the peak inflation narrative as a signal to buy. However a plateau is not the same as a peak and they will find it lingers higher for longer, and the labour market will remain tight = more hikes. 

Traders have pared bets on the Fed moving above 5% by the end of 2023 in the last week. I feel this is overly optimistic. 

Terry Smith on Unilever, share-based compensation and the end of easy money  

Some choice words from Terry Smith, head of Fundsmith. Some of the choicest cuts were reserved for Unilever. Smith has been a long-time critic of management, particularly some value-destroying acquisitions that he points out management don’t really like talking about, or disclosing how much they paid, like Dollar Shave Club. There was also an air of irritation about the way ‘activists’ can stride in, buy a stake and get a seat on the board whilst large longer-term investors such as Smith are left in the dark. There is a lot of truth in this – why are long-term backers sidelined for these loud American activists. Time to listen to the quiet Brits!  

And there was a swipe at share-based compensation. Or at least, a swipe at the way some companies use this to distract from their actual earnings per share. In the case of Intuit, he says, it would imply that the company is not in fact trading at a trailing twelve-month free cash flow yield of 3.5%. “Removing $1.5bn of share-based compensation from the $4.1bn of operating cash flow reported in the cash flow statement would leave Intuit’s free cash flow yield much lower, at 2.2%. This example gives a sense of the magnitude of distortion that the accounting for share-based compensation could inflict on free cash flow yields,” Smith writes in his annual letter to shareholders.  

Finally, Smith attributes the fund’s underperformance on the “painful” end of easy money. This could be seen as too easy an excuse, but it’s hard to disagree that the sharp tightening by central banks and removal of liquidity post-pandemic has been the primary cause of stock market turmoil in the last 12 months. Well worth a read. 

Sainsbury’s reports ‘record’ Christmas  

Sainsbury’s (SBRY) delivered an upbeat trading update, saying Christmas and Q3 Grocery volume performance was ahead of the market for the third consecutive year, whilst General Merchandise growth was stronger than expected. Q3 like-for-like sales rose 5.9%, with Grocery +7.1%. But with food inflation running at 13% at the moment I am not seeing a heck of a lot to cheer here…fag packet arithmetic suggests there is not a lot of volume growth (contraction?) here, but we need to see more detail. Perhaps that is why shares are off 3% or so this morning. Profits are expected to be at the upper end of the guidance range of £630 million to £690 million, but remains cautious on the consumer outlook. Not a single mention of the word ‘margin’ in the release is suspect… 

Also in the Markets 

Meme stock favourite Bed Bath & Beyond reported a wider-than-expected quarterly loss only a few days after it warned of a potential bankruptcy. Losses widened to $393mn in the three months to the end of November. Comparable sales were down 32% in the quarter from a year before. BBBY jumped as it didn’t declare bankruptcy but is still down about 25% in the last five days and down 87% in the last 12 months. Fresh job cuts at Coinbase – another 20% of its workforce...shares rose a touch having leapt about 15% on the Jefferies upgrade. Meanwhile Binance outflows are getting worse.  

Gold has risen to its highest since April last year as a combination of slower Fed rate hikes and persistent inflation have left traders backing the metal, which is up about 16% from its Sep-Oct-Nov bottom. A weaker dollar, which is about 10% off the multi-year highs hit in September, has also underpinned the rally. Golden cross forming with the next big test at the 38.2% retracement round number resistance around the $1,900 level. If that goes then the April 2022 swing high at $2,000 becomes possible. Copper – still going. Three white soldiers turned into four, with this reasonably reliable indicator highlighting a clear upwards trend in copper in the wake of the bullish MACD crossover. Price action is firmer again today with possible ‘golden cross’ forming.