MSFT - Get Your Shopping List Ready But Remain Hedged; I'm A Reluctant Bear

2023-09-10 21:39:13 ET

Summary

• Market-moving news expected this week, including UAW strike, inflation data, and Fed narrative on interest rates.
• Arm Holdings IPO may disappoint due to flat revenue and high valuation.
• Apple's stock may continue to slide due to the Chinese ban and low expectations for iPhone sales.

There will be a lot of market-moving news this week

This week has a lot of known unknowns to be discovered, Does the strident leader of the UAW strike all three unionized car makers this week? Will the CPI and PPI beat estimates on lower inflation (Just meeting estimates won't be good enough)? Will the Fed narrative remain “higher for longer”? Pushing the 10-year to break above 4.30% or will it retreat under 4.20% again? Keep in mind that 4.36% is the multi-decade high for the 10-year treasury bill. Next week September 20. is the FOMC meeting the Fed Funds Rate announcement, there will likely be another rise. It is even more likely that we will not see a cut either. In anticipation of the Fed statement “higher for longer” will the 2-year note move toward 5.5% which was the rate level voted in June? If the debt market is convinced that the FFR rates will remain at least at 5.5% with a small possibility of a raise in November the 2-Y will move back above 5% and make new highs?

Forewarned is Fore-ARMed

We have the Arm Holdings ( ARM ) IPO next week, a semiconductor IPO that if successful will draw funds from other technology names. I suspect that even though it has been "over-subscribed" it will be a disappointment. ARM set a price in the range of 47 to 52 a share which is about $50B in market cap. You want to be in an IPO that is shooting for the stars, however, ARM's revenue has been flat last year, and at around 52 it would be valued at 20 times revenue. That is about equal in value to NVDA. They have made all sorts of promises in the road show that growth will re-ignite going forward. I find it hard to believe that ARM will achieve NVDA's growth. A failed IPO that has been strongly hyped will leave a mark on market sentiment, I believe.

Whither Apple ( AAPL ) goes so goes the market

Apple is expected to announce the iPhone 15s at its annual fall event dubbed Wonderlust on September 12. Last week the stock fell 6% on news that the Chinese Communist Party banned the iPhone from government offices. Both Reuters and AP reported that the ban is much wider, reaching State-Owned Enterprises (SOE). SOEs are largely in the old economy sector but employ a huge number of workers. China accounts for about 20% of the company's total revenues. Will the selling continue, since there is really nothing exciting for AAPL to announce this time? AAPL bulls are counting on the replacement rate ginning up sales. AT&T ( T ) CEO John Stankey in an interview with David Faber on CNBC revealed that uptake of the iPhone is not expected to be strong; “... generally speaking, the devices are getting a bit more expensive and I think consumers are being a little bit more guarded and how frequently that they’re upgrading. So I think it’ll do well. I don’t have any reason to expect that’s the case but I think consumers right now will be a little bit selective if they can defer ultimately replacing the device.” Clearly, Mr. Stankey, who has better knowledge regarding AAPL products than we do, is not impressed. There is a better than even chance that AAPL will continue to slide leading into the “Wonderlust” event. I say this even if there's a cessation of rumors regarding the CCP’s widening banishment of the iPhone in China.

I hate to mix geopolitics with stocks because they rarely intersect but President Xi, snubbing the G20 and ASEAN summits is not helping stocks that do a lot of business in China. There are rumors that XI will be a no-show at the UN General Assembly where XI and President Biden were to meet. To show that I am not just picking on AAPL, look at how Boeing ( BA ) fared so far this month -7%. I haven’t looked but I bet Starbucks ( SBUX ) isn’t doing much better – down almost 4% (doing a little better). It’s pretty clear that the US-China relationship has seen better days, and in my humble opinion is likely to get worse, not better. In the long run, it's not totally meaningful to stocks but right now it does.

I’ve whipped up a pretty negative cocktail, but any practiced bear can do this at any time. What’s up?

It’s September, and maybe it is PTSD on my part, but the memories of September and the beginning of October past, have been giving me agita. Perhaps the above litany of negativity is my way of self-soothing because I am heavily hedged right now. So far the hedging is working for me, any downturn has been counteracted by all the inverse positions that I have right now. In fact, my value grew last week in spite of the overall market retreat. I am breaking my own rules, perhaps bending them, I have been hedged way too long than I like to be. Remember the market goes up about 80% of the time, so the odds are, if you stay against the market too long you will be caught out. Also taking a step back, the economy is doing great. It is very likely that the economy grew faster this quarter than last. Inflation news even with the growth has been encouraging. It follows that the S&P 500 earnings for Q3 will be higher, justifying a higher valuation of stocks. Since market participants look out 6 to 9 months ahead one could justify a higher PE for the overall market. I say the market’s PE to keep the “Magnificent 7” high valuation to the side. I think they are going through a bit of a readjustment right now, though it might be very temporary, and it is why I feel like staying hedged makes sense. If the economy is strengthening, and the Fed is very likely on hold for most of 2024 as well, then the earnings power of the very best big-cap growth stocks is less valuable. Names like Microsoft ( MSFT ) with its prodigious and reliable profits are of course highly valued. I am saying that if an oil stock like Pioneer Natural Resources ( PXD ) can return 10% cash dividend or perhaps higher with oil approaching $90, or Caterpillar ( CAT ) with monthly construction spending rising to $1.972 billion in July, increasing 5.5% from 2022 levels, the U.S. Census Bureau announced Sept. 1. Meanwhile, CAT earnings accelerated in the past two quarters, jumping 75% for its most recent report on Aug. 1. With that kind of growth, and the potential for it to accelerate even more, perhaps CAT will steal some buyers from a MSFT or an AAPL? I think PE ratios for a range of the Tech Titans will contract a bit. Currently, big-cap growth stocks are considered a safe haven, especially in an economic slowdown. Right now the picture is decidedly in the growth camp, though I am unsure how long the growth narrative remains the dominant view. I still feel that we can easily see recession talk gain primacy as I said in last week’s analysis. The Fed is still looking for the economy to slow down. The question is will they take yes for an answer? In other words, will the economic reports that have been showing disinflation be acceptable to the Fed even when the economy continues to grow?

One last note about CPI this week...

Economists estimate August headline inflation rose 3.6% over the prior year, up from the 3.2% rise seen in July. Prices are estimated to be +0.6% on a monthly basis. Higher energy prices are expected to be the culprit for the higher costs. The Core inflation measure stripping out food and energy prices, CPI is forecast to rise 4.3% over last year in August, a slowdown from the 4.7% increase seen in July. Monthly core price increases are expected to clock in at 0.2%. Any of these numbers, especially in the Core measure increase and I will be very happy to have all these hedges on. There is a super-core that seeks to isolate services inflation that the Fed has been even more focused on and that could perturb the market. As an aside the service PMI data revealed last week showed the Prices Index was up 2.1 percentage points in August, and employment is up 4% from 50.7 to 54.7, PMI numbers are based on 50, anything above 50 means growth, so 4% is significant. The question is, will this be reflected in the “Super Core”, I suspect yes.

A caveat here, I am biased

There is no question that my leaning on the bear’s side is influenced by my exposure to an inverse strategy. Meaning that if the market goes down I make out like a bandit. So perhaps paradoxically that is my biggest worry. Can all the data reveal end up showing that the economy is so balanced that it is no longer generating higher prices because of unfillable demand? Absolutely, yes. We saw the Worker Participation Rate move up, which is highly encouraging for labor costs. Just this Friday we saw anecdotal evidence of lower labor costs with Walmart (WMT) lowering its pay for new workers. WMT has a huge influence on a whole swath of service employment in the retail sector. So for the moment, this is my pain trade, staying hedged. As the pivot point on stock prices is getting closer, remaining on target gets more fraught. In other words, I will be "white knuckles" holding my bearish bets, while in my heart the economy could come out of these short weeks in really great condition.

What will I do this week, and what is on my shopping list?

I hope to close out all my inverse index positions for now and convert them to cash. If I am correct stocks will likely be oversold. So what would I be buying? The very stocks that I expect to be giving up the most ground, namely the large-cap tech stocks. I have been mostly avoiding them lately because they’re so well-priced, I hope to correct that this week and next. I went so far as to create a shopping list for Group Mind Investing members, replete with charts and annotations on where the support is. Frankly, it will be a relief to be on the bullish side of stocks. I am a very uncomfortable bear.

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