Corporate earnings reports sent the Dow Jones Industrial and Nasdaq Composite in opposite directions yesterday, while the S&P 500 finished close to flat. Shares of Netflix plunged 35% to $226 after the company announced it had lost 200,000 subscribers in the latest quarter and would lose 2 million more in the current one. Granted, pulling out of Russia cost the company 700,000 subscribers, but that doesn’t explain the unexpected losses moving forward.
Communication services was the worst-performing S&P 500 sector, as nearly every company that has a subscriber-based content business traded lower in sympathy with Netflix. Bears may construe this as the first sign that consumers are cutting back on spending, which feeds into forecasts for recession and a bear market decline in stocks. Articles calling for a “market crash” in the next 12-18 months are becoming more frequent, but I think this is nonsense. What I found notable about yesterday’s trading is that while Netflix was crumbling, the share of Marriott International (MAR) was trading at a new all-time high.
Consumers are not cutting back as much as they are shifting their spending priorities from goods to services and from the couch in the living room to the road and airways. Sure, prices have gone up, but so have incomes. The pandemic-related relief programs have ended, but tax refunds are up 10% from last year, increasing to an average of more than $3,000 per household. Debt-service ratios are near record lows of 10%, which is well below the 13.7% that existed prior to the recession in 2008. Most importantly, American consumers who account for two-thirds of economic growth are sitting on a fuel tank of more than $4 trillion, which helps to offset the higher costs they face today. This is the most underappreciated fact by those Wall Street strategists who are rushing to call for a recession and bear market over the coming 12-24 months.
Investors should be careful not to conflate market performance with economic performance. The economy is firing on all cylinders, despite the moaning and groaning that shows up in sentiment surveys. The market is going through a valuation adjustment to account for higher interest rates and an elevated rate of inflation, which is a phenomenon I asserted would happen in my outlook for 2022 at the beginning of this year. Yesterday’s collapse in Netflix is just another step in that process, as the shares were grossly overvalued heading into the company’s earnings report. Its decline follows that of the most expensive momentum names that make up Cathie Wood’s ARK Innovation portfolio, which has declined an average of 40% this year. The ARK may have sunk, but it does not have to take the stock market with it.
As a result, investors are reallocating out of expensive growth stocks and bonds into more value-oriented companies and commodities. This has happened so rapidly that I am now starting to see some fixed-income securities as viable long-term investments. The real rate (inflation-adjusted) on the 10-year Treasury briefly turned positive this week for the first time since before the pandemic. Preferred securities can now be found at discounts to par value ($25) and corporate bonds at the lower end of investment-grade with 5-year maturities have yields of 5-6%. I have not seen opportunities like this since early 2019.
The pandemic trade may be over, but the bull market is not. We are simply moving into a different stage of it during which value should outperform growth. The Fed may be tightening monetary policy, but the economic expansion is not ending, as excess savings and a robust labor market should fuel continued growth. I think the peak in the rate of inflation is behind us, which means that long-term bond yields may level off over the short-to-intermediate term. A pullback in the commodity complex also looks probably, which could be the catalyst for a move higher in the major market averages on the tailcoats of better-than-expected earnings for the first quarter.
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