Flagship Pod 86: Inflation cools, China fears, Why markets are down

08/14/2023

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Now let's get into what we reviewed.

Here are the 4 key things we went over:

How we see inflation playing out
Why we're becoming concerned about the Chinese economy and how it could massively affect US markets
What stocks will win in this phase of the recovery
What we're focusing on in the back half of earnings season

And if you're too busy to listen to the entire recording, below we included a compact summary of what went down. To get all the juicy details, just listen to the entire recording. And now, onto the summary 👇

Overview:

With the big players done reporting, the market is going to turn choppy until the end of next week when Nvidia either confirms or breaks the momentum of the current AI rally.

Right now, it only appears that the biggest players are moving with any momentum as we push toward the end of this inflationary crisis.

Last week's CPI and PPI basically confirmed that even with steadily rising oil prices, other aspects of inflation are getting under control enough that we may actually be approaching the end of this inflationary spiral without crashing the whole economy.

Sure, we had a week of scary headlines like a bunch of banks getting downgraded and consumer credit card debt surpassing $1 trillion, but all of these things can be explained and digested by just how massive this economy is.

Right now, the biggest threat to investors is simply a market that is so cagey that it would rather pick winners and losers across industries than be patient with current valuations. Strong companies are getting hammered by mildly missing revenue goals or simply not beating their guidance hard enough.

Good vibes are definitely on the rise, but if this punishing rate environment lasts until the end of 2024, we're going to need to be cautious and calculating for a lot longer.

And last but not least, one huge fear emerging is that China could take down the global economy. Is this legit or are the fears overblown? More on this in the audio report.

So, let's get a better understanding of what criteria are really powering this market so we can make the best long-term decisions moving forward. 👇

Inflation is Looking Great:

It's counterintuitive to say, but investors were ecstatic when inflation rose a little compared to last month.

There are two big factors here powering the market's positive reaction:

Inflation is staying pretty flat despite a huge rise in oil prices. Basically, Oil is up over $20 a barrel since June, and prices in July really did not reflect that. That's because other prices in the economy are falling quickly enough to offset the regression of energy costs. You can expect rising energy costs through the end of the summer, so the market isn't getting too worried about Saudi Arabia and the rest of OPEC+ limiting supply enough to drive oil prices back up.
More importantly, all of the prices that are still high typically are slow to react to rate hikes. The economy is super complex and it takes a long time for Fed policy to actually fully permeate the market. The slowest of these factors is rent. Housing inflation is currently one of the stickiest line items in the CPI, but is finally making a mild turn downward. Removing rent's contributions to inflation puts the market squarely in the Fed's preferred 2% range for inflation, even with rising oil prices. In short, housing inflation is starting to crack and should continue to crumble further, suggesting that we're really starting to see a consistent end to inflation. We'll still see potentially one more rate hike sometime this year and the beginning of talks about lowering interest rates by the end of the year. However, it's going to be a long time until we actually start seeing the fed behave in a dovish way again. Which dovetails nicely into our next segment:

Consumer Spending in Focus:

This is one of the biggest factors we're watching this week as we try to gauge the likelihood of a 'soft landing' for this economy.

Essentially, it's clear that the Fed is getting inflation under control and we'll find a way out of this crisis without spiraling into hyperinflation and collapse.

However, in order for inflation to be fully squashed, we need to make it through to the end of 2024 without a complete collapse of consumer spending.

And basically, 'doomers' were really highlighting the fact that consumer credit card debt has surpassed $1 trillion. In short, it's super easy to build a narrative that the strength of American consumers is based entirely on credit card debt and that this whole house of cards can come crashing down really quickly.

But that's a real flimsy narrative, because compared to real wages, credit card debt passing $1 trillion isn't all that onerous. To be fair, once the interest rates fueled by higher Fed rates kick in around the beginning of 2024, anyone with an outstanding credit card balance is going to get absolutely pummeled by the iron laws of compound interest.

But, the real strength of this economy is in people whose debts weren't really all that changed by the last 3 years. The spending base of this economy is a giant pile of wealth called the baby boomer generation, which has a huge amount of housing debt (70% of all consumer credit) that is locked in at basement-level rates set during the boom times of the 2010s.

Sure, if we can't get interest rates under control by 2025, we're going to start seeing some long-term damage, but it honestly is going to take a hell of a lot to defeat America's ability to spend on things.

Our main concern right now is simply how sharp the transition from spending on goods to experiences is.

Therefore, we're going to watch the numbers and commentary coming out of Walmart and Target's earnings calls later this week to gauge how strong the fundamentals of consumer spending are. Last quarter we heard a lot of noise about shifting towards essentials.

Can management at our core retailers shift spending so they stay profitable if all their consumers are only buying absolute essentials instead of buying wants instead of needs?

Wrapping This Up:

The actual podcast also focuses on a deep dive into the developing criteria we have when it comes to how we're determining who can be a winner and loser in this market. We definitely recommend listening.

Basically, a lot of the shareholder value is simply shifting towards companies perceived to be at 'the top' of a particular category.

While numbers are still strong at American Airlines, they aren't winning nearly as hard as United and Delta. Meanwhile, Blackstone is staying strong despite worries about their real estate portfolio essentially because they're at the top of their perceived segment.

There's a lot to like in this market, but investors seem to be a lot more likely to bail on you than hold your stock if you have even the slightest bit of perceived weakness.

Keep your time horizons long and you'll outperform the cagier aspects of this market.

We'll keep you updated as things develop.