Macro Roundup

Since the March 2020 sellout, the average S&P 500 stock has outperformed the NYSE FANG+ index. “It is only now that investors have fully grasped that shouldn’t be valued as though the pandemic conditions would continue forever.”

“…This incident is very much about mega-cap tech and the premium it deserves over the rest of the market. Looking at the ratio between the S&P 500 Equal Weight Index, in which each stock has a 0.2% weighting regardless of its size, and the standard S&P 500 benchmark, illustrates just how much tech shares weigh down the index when the average stock isn’t doing so badly. The average stock has comfortably beaten the index so far this year. The average S&P 500 stock has now outperformed the NYSE FANG+ index since the nadir of the Covid-19 selloff in March 2020….”

John Authers, "Wile E. Coyote Moment as Tech Goes Off the Cliff,"Bloomberg, October 28, 2022, https://www.bloomberg.com/opinion/articles/2022-10-28/tech-s-fangs-plummet-in-wile-e-coyote-moment-on-earnings

Wile E. Coyote Moment as Tech Goes Off the Cliff

Crash Landing

There is no character in the entire canon of world literature and drama more useful for explaining markets than Wile E. Coyote. In the Roadrunner cartoons, he would run off the edge of a cliff, and continue running into midair. Only once he stopped, looked down, and realized that he was in midair, did he fall. He thus gave the market the invaluable concept of a Wile E. Coyote moment, when investors realize they’ve been running without support for a long time, and prices that should have long since been gradually coming down suddenly collapse.

The laws of physics make what the coyote does impossible. But markets are driven by human nature and crowd psychology. Coyotes can defy gravity for years in the markets — but generally there comes a point when the game is up. And this week has seen the FANGs (the acronym for the huge internet platform groups that originally stood for Facebook, Amazon, Netflix and Google when coined) respond to gravity at last.

Netflix had well-received results last week; but Microsoft Corp., Google-owner Alphabet Inc., Amazon.com Inc. and even Apple Inc. have all this week suffered sharp writedowns, while the treatment meted out to Meta Platforms Inc., the Facebook parent, has been savage. Since Tuesday evening when its results came out, Meta’s stock has been punished horribly for a disappointing revenue forecast, despite Mark Zuckerberg asking for patience given the social-media giant’s growing investments, particularly in the metaverse. The stock has plunged 25% Thursday and 70% year-to-date:

Another important way to illustrate the scale of what’s going on involves comparing market capitalizations. The market value of Meta has slipped by $676 billion this year, pushing it out of the world’s top 20 largest companies. At one point it was the fifth-largest in the US, valued at more than $1 trillion, and almost three times the size of the biggest US bricks-and-mortar retailer, Walmart Inc. Now, for the first time since 2015, Meta is smaller than Walmart:

This is all a tad reminiscent of the period of a few weeks in early 2000 when dot-com investors suddenly moved from metrics like “clicks per eyeball” to “burn rate” — an old metric with a new name, referring to how quickly startup companies were burning through their cash flow. Meta has become a vastly more substantial and tangible concern than the entities that evaporated 22 years ago, but the sudden and swift realization that it had been valued far too generously still rings those bells.

The FANGs’ crisis of confidence is all the more interesting because it comes just as bond yields are falling and optimism is growing that central banks will soon relent (of which more below). In fact, the pessimism from Meta, given the company’s sheer size, even overshadowed the positive gross domestic product data Thursday, according to Nicole Webb, SVP and financial adviser at Wealth Enhancement Group. The stock’s slide has had “such a global impact” that it may prompt a broader market recalibration: "I appreciate seeing a slowdown in the mega-cap tech companies. I have always had this thesis that trades don’t grow from the sky. And I think Silicon Valley is showing a bit of its age in that they really ever had to be thoughtful about hiring, layoffs and restructuring."

She may be right. This incident is very much about mega-cap tech, and the premium it deserves over the rest of the market. Looking at the ratio between the S&P 500 Equal Weight Index, in which each stock has a 0.2% weighting regardless of its size, and the standard S&P 500 benchmark, illustrates just how much tech shares weigh down the index when the average stock isn’t doing so badly. The average stock has comfortably beaten the index so far this year:

For Anthony Saglimbene, chief market strategist at Ameriprise Financial, what’s happening is simply the divergence between the old economy and the new economy.

Old economy stocks, he said, comprise those that are value-based, which typically perform better due to their stable earning streams. This is where investors are gravitating now, especially since they are less sensitive to rate increases. The new economy, on the other hand, include high-growth tech names that are prone to fears of rising interest rates, since many of them are valued based on their projected profits far into the future. And as the Fed forges on with its most aggressive tightening monetary policy in decades, the future profits of tech firms will be worth far less.

Unfortunately for the tech sector, the bad news continued at the end of the day, when it was the turn of Amazon.com Inc. to feel the market’s wrath in after-hours trading. Its third-quarter earnings were above prior expectations, but a particularly sanguine warning that the coming holiday season isn’t going to be a good one for sales prompted investor flight. The stock plummeted 20% at one point in extended trading.

For now, other parts of the market are enjoying a boost — companies that warmly fill tummies, bring us to exciting places, and entertain us with endless movies. To Webb, it’s simply a matter of everyone getting their time, as companies that were hurt by the pandemic return to normal: "McDonalds is such a great story in the psyche of the consumer as is Chipotle as is Boeing... When you think about the world today, kids are back in school so it’s not surprising Netflix has new subscribers again. Well now we are back to the school year, winter is coming. Everyone is back to normal activity. Return to normalcy will prevail the trade."

More telling still was the judgment of Louis Navellier, a veteran growth investor who has cheered fast-growing tech stocks in the past, and has made a fortune by looking at growth prospects rather than valuations. He pointed out that Meta’s spending on the metaverse would likely have a long payback, and that the Dow Jones Industrial Average was still up for the day thanks to strong numbers from McDonald’s Corp. and a range of other old-world names that earn their money from making things and selling them to people, including Honeywell International Inc., Caterpillar Inc., Boeing Co. and Merck & Co. Inc. Amid the bloodbath for tech companies, McDonald’s shares have somehow managed to rise slightly for the year so far.

Navellier suggests that assumptions about tech that have survived for the best part of a quarter century are at last being revised: "Consider that both Microsoft and ExxonMobil are currently generating roughly the same amount of free cash flow yet Exxon has a market value of only 25% of Microsoft. If the economy continues to slow as the Fed intends, the leadership that tech has enjoyed for many years may be brought back down to earth by valuation adjustments."

And as the Wile E. Coyote moment demonstrates, now that those valuations are at last being examined critically, not even the prospect of lower interest rates can keep the FANGs levitating.

Cruise Path to a Soft Landing (???)

While the FANGs made a crash landing, the top-down macro world is providing much news that investors had been hoping to hear. The European Central Bank met and hiked rates by 75 basis points as expected, but President Christine Lagarde signaled very clearly in her press conference (which you can see here) that we should expect the rate of increases to slow down from now on. Previously, the ECB had alerted that it expected to raise rates at “the next several meetings.” Now, under questioning, Lagarde was much more hedged: "Our sense is that we have already made significant progress, as I said. We are not done yet. There is more ground to cover, and the question of what that pace will be — what will be the magnitude of future rates — will be determined meeting by meeting and will be data dependent."

That had an immediate impact on the implicit path of interest rates projected by the overnight index swaps market. Expectations had risen sharply over the summer, but Lagarde’s words helped cut projected rates for next year by 25 basis points:

Shortly after, US GDP numbers for the third quarter were released, and were almost perfectly “Goldilocks” (not too hot, not too cold) as far as the market is concerned. GDP is growing, but consumption is slowing, a combination that should allow some kind of “soft landing.” Bond yields did reduce, with the 10-year Treasury yield dropping below 4% for the first time in two weeks, but not in a way that saved the stock market from a tough day.

One reason for this is that the third quarter’s GDP number of 2.6% is already well in the past. Friday’s release of Personal Consumption Expenditure inflation data, the Fed’s favorite measure and within days of a monetary policy decision, promises to be far more important. Expectations for PCE are widely dispersed, but everyone thinks that they will show a rise. If the number comes in at the bottom of the range of expectations, that could have a much powerful effect on bond yields:

As the FANGs continue their crash landing, there are still hopes of a soft landing for the bond market. That could yet translate into one for the stock market as well, as some ludicrous valuations are corrected, and capital diverts to some places that have been starved of it but could use it. The readjustment from the pandemic seems to be over — but bonds and tech stocks are reassessing assumptions that have stood for a couple of decades or more. This is tricky to engineer. The path to a safe landing might exist, but it’s a perilous one.

"...Studies have repeatedly shown that most predatory crime is committed by a small, hard-core group of habitual offenders. They are a tiny fraction of the population—I estimate roughly 1%—but are responsible for between half and two-thirds of predatory violent crime. Each of these offenders can be expected to commit scores, even hundreds, of crimes a year, frequently while on bail, probation or parole. The only time they aren’t committing crimes is when they’re in prison. For this group, the likelihood of reoffending usually doesn’t recede until they reach their late 30s. The only way to reduce violent crime appreciably is to keep this cohort off the streets…By 1992, as more violent offenders were incarcerated, the trajectory of violent crime started falling for the first time in decades. Presidents Bill Clinton and George W. Bush continued these policies, andfrom 1991 to 2013, the total prison population in the U.S. doubled—from roughly 800,000 to 1.6 million. At the same time, violent crime plummeted, dropping for 23 years. By 2014 it had been cut in half—to a level not seen since 1970..."

William Barr, "Rising Crime Rates Are a Policy Choice,"Wall Street Journal, October 26, 2022, https://www.wsj.com/articles/safe-streets-are-a-policy-choice-incapacitation-incarceration-state-federal-prison-violent-crime-1990s-reagan-bush-barr-obama-sentencing-bail-11666785403

Rising Crime Rates Are a Policy Choice

The violent crime surge was preventable. It was caused by progressive politicians reverting to the same reckless revolving-door policies that during the 1960s and ’70s produced the greatest tsunami of violent crime in American history. We reversed that earlier crime wave with the tough anticrime measures adopted during the Reagan-Bush era. We can stop this one as well.

Studies have repeatedly shown that most predatory crime is committed by a small, hard-core group of habitual offenders. They are a tiny fraction of the population—I estimate roughly 1%—but are responsible for between half and two-thirds of predatory violent crime. Each of these offenders can be expected to commit scores, even hundreds, of crimes a year, frequently while on bail, probation or parole. The only time they aren’t committing crimes is when they’re in prison. For this group, the likelihood of reoffending usually doesn’t recede until they reach their late 30s.

The only way to reduce violent crime appreciably is to keep this cohort off the streets. We know with certainty that for each of these criminals held in prison, there are hundreds of people who aren’t being victimized. This “incapacitation” strategy requires laws, like those in the federal system, that allow judges to detain repeat offenders before trial when they pose a danger to the community, and that impose tough sentences on repeat violent offenders.

History shows this strategy works. Before 1960, violent crime in the U.S. was modest and stable. In the early ’60s, however, liberal reformers pushed to turn state justice systems into revolving doors, with violent offenders quickly released on parole or probation. Predictably, violent crime exploded, going from 160 crimes per 100,000 population in 1960 to 758 per 100,000 in 1991.

In the 1980s, the Reagan administration and several large states started locking up violent offenders, and the nation’s prison population rose from about 300,000 to almost 700,000. This radically flattened the rate of violent crime, which rose only 11% during the ’80s. By 1991, when I first became attorney general, the revolving door was in overdrive in many states. Nationally, murderers served less than six years on average; the average time served for rape was three years. In Texas, offenders typically served only 15% of their sentences. Five of 8 felons released from prison were arrested for new crimes within three years.

The George H.W. Bush administration initiated the doubling of federal prison capacity, pushed states to do likewise, and launched a broad movement to toughen up state justice systems. It also greatly expanded joint federal, state and local task forces to target the worst violent criminals for stiff sentences under federal gun, gang and drug-trafficking laws.

The results of these policies were stunning. By 1992, as more violent offenders were incarcerated, the trajectory of violent crime started falling for the first time in decades. Presidents Bill Clinton and George W. Bush continued these policies, and from 1991 to 2013, the total prison population in the U.S. doubled—from roughly 800,000 to 1.6 million. At the same time, violent crime plummeted, dropping for 23 years. By 2014 it had been cut in half—to a level not seen since 1970—and homicides of black victims were down by about 5,000 a year.

Nevertheless, progressives complained: Why were we imprisoning record numbers when crime was receding? They missed the point. Crime was dropping precisely because we were keeping violent criminals in prison. Progressives call this “mass incarceration,” but their rhetoric is deceptive. It implies people are being locked up indiscriminately. On the contrary, incapacitation is a precision strategy. It targets and uses prison space primarily for violent criminals who pose the greatest threat to public safety.

Unfortunately, 23 years of successful crime reduction came to an end with the resurgence of progressive policies in the Obama administration, which saw a return to the revolving door and the demonization of police. Incarceration rates started falling again, and by 2014 crime rates were headed back up. This reversal was temporarily halted by the Trump administration, which succeeded in driving violent crime down until the summer of 2020. It started to climb in the wake of the Covid pandemic and the Black Lives Matter riots. It continues to rise without any end in sight.

Progressives have no solution. As in the ’60s, they call for more social spending to address the supposed “root causes” of violent crime. But even if we knew how to address the root causes effectively, which we don’t, implementing the solution would take decades. People are entitled to protection now. Even the best-designed social programs have no chance of success in neighborhoods strangled by violence and fear. Law and order is a prerequisite for social progress.

Progressives say we can’t afford to keep violent predators in prison. On the contrary, we can’t afford not to. A 1992 Justice Department report, “The Case for More Incarceration,” showed that the cost of keeping a chronic violent criminal in prison is small compared with the costs of letting him roam the streets.

In other contexts, we spend huge amounts to reduce the risk of premature death or injury to members of the public, including billions on highway safety or environmental quality. If we started using the same cost-benefit analysis for law enforcement, we would be spending many times more than we do today on police and corrections.

The very purpose of government is to secure a peaceful society—making life safe for law-abiding citizens by protecting them from violent predators. Progressive politicians are doing the opposite, blighting the lives of the law-abiding with their warped solicitude for the criminal few. We can stop the swelling crime wave only by rejecting these politicians and their destructive policies. It is time for a return to sanity.

“…Republican candidates are facing substantially more scrutiny in the mainstream media than Democrats leading up to the midterm elections, with news outlets airing negative coverage of the GOPers 87% of the time, A study found.Democrats, meanwhile, were on the receiving end of bad press 67% of the time, according to the study conducted by the conservative Media Research Center…”

Victor Nava, "Mainstream media gives GOP negative press 87% of the time in midterm run-up: study,"New York Post, November 3, 2022, https://nypost.com/2022/11/03/mainstream-media-gives-gop-87-negative-press-in-midterm-run-up-study/

Mainstream media gives GOP negative press 87% of the time in midterm run-up: study

Republican candidates are facing substantially more scrutiny in the mainstream media than Democrats leading up to the midterm elections, with news outlets airing negative coverage of the GOPers 87% of the time, A study found.

Democrats, meanwhile, were on the receiving end of bad press 67% of the time, according to the study conducted by the conservative Media Research Center.

The study of ABC, CBS and NBC’s nightly newscasts also found that President Biden is drawing far less criticism in 2022 than former President Donald Trump did during the 2018 midterm elections.

Trump accounted for 48% of all midterm campaign airtime on nightly newscasts in 2018, more than all the congressional and gubernatorial candidates combined, and it was mostly negative, according to MRC.

In comparison, Biden coverage during the 2022 midterms has accounted for only 16% of the networks’ coverage. And while the president has received mostly negative coverage during the study’s time frame, it is on a far smaller scale than Trump did - seven negative comments made against Biden compared to 54 for Trump.

Overall, the study found that Biden and Democratic candidates drew 13 positive comments and 26 negative ones, or 67% negative.

The GOP, however, were hammered with 94 negative comments and only 14 positive statements, or 87% negative.

MRC further breaks down the numbers and finds that three Republican candidates and one Democrat generated most of the bad press.

Republicans Herschel Walker, Mehmet Oz and Kari Lake, and Democrat John Fetterman.

Fetterman’s 81% negative coverage was the worst of any Democrat and mostly centered on his widely panned debate performance against Oz last month.

Arizona Republican gubernatorial candidate Kari Lake had the most negative score of all candidates with a 100% bad press rating.

The study took place between Sept. 1 and Oct. 26.