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Lessons From a Chaotic Year

Olga and Hugo review their predictions and explore what surprised them in 2022, focusing on gross domestic product (GDP), interest rates, earnings growth,…



Olga and Hugo review their predictions and explore what surprised them in 2022, focusing on gross domestic product (GDP), interest rates, earnings growth, energy prices, and the dollar.

Hugo: Olga, this has been quite the year for us to review. Some major events happened that very few people expected. Others were more foreseeable, but they might not have played out exactly as forecast.

As is customary for us, let’s start by talking about economic growth. What do you think nominal GDP will have been in the United States this year? And do you believe that it could be the source to help us understand many other things that happened in 2022?

Olga: Traditionally, Hugo, economists focus on real GDP growth, but you’re quite right that understanding nominal growth is also important, in part because corporate sales and earnings are usually discussed in nominal terms.

Our forecast for nominal GDP incorporates expectations for both growth and inflation. We were on the right track by anticipating the significant deceleration in growth. But growth slowed in line with what we and many others expected, while inflation was higher. On balance, nominal GDP actually held up better than we had predicted, but that was driven by higher inflation than we expected at the beginning of the year.

The suddenness of the Russia-Ukraine conflict, the unpredictability, is what drives the inflationary impulse.

Hugo: What were the drivers of inflation?

Olga: Inflation was so strong not least because it was exacerbated by geopolitical tension. The Russia-Ukraine conflict certainly didn’t help here. The suddenness of the conflict, the unpredictability, is what drives the inflationary impulse.

This was specifically relevant for the energy-procurement disruption for Europe. To the extent that Europe was able to buy energy from elsewhere, it was displacing barrels of oil and liquified natural gas (LNG) that other countries could buy, especially lower-middle-income countries. That was a tremendous impetus to inflation.

Having said that, if we take a step back and look at the federal funds rates from 2015 to 2019, pre-pandemic, we see that the neutral rate for the United States was between 3.5% and 4.5%. That equates to a 1% to 1.5% real rate plus 2% inflation.

The U.S. Federal Reserve (Fed) started 2022 with rates basically at zero, so it needed to move to a neutral position very quickly. Despite the significant tightening of its rhetoric since June, at the end of the year we’re at the upper end of this range. This means we’re basically in the band of neutral rates.

Now, do we stop at 5%? Do we stop at 4.75%? The basic point here is that despite all the rhetoric, the volatility, and the unpredictability of the geopolitical disruptions, we are essentially in line with where we think the neutral rate should be, even based on pre-COVID assumptions.

Hugo: How do you define the neutral rate?

Olga: It’s the nominal rate minus inflation. For the United States, as a developed economy, its real rate should be somewhere on the order of 1% to 1.5%. It’s not too restrictive and not too accommodative. If inflation is 2% to 3%, that puts the nominal rate between 3.5% and 4.5%.

Hugo: The strength of nominal GDP growth in the United States, you were clear in saying, could happen. You said interest rates have ended up at a neutral rate, but the speed of rate increases seems unusual. It’s not often that you see rates move so much in one year, at such a clip, with 75-basis-point increases.

Were you surprised, as you look back, at the pace of interest rate increases? For anyone who started their investing career in 2010 or even 2000, it’s not what they’re used to.

I think the idea right now that the Fed is going to overtighten and then have to start loosening right away is either a misinterpretation or wishful thinking.

Olga: I was surprised, in part, because I didn’t think about it very much. I knew where the rates were, and I knew where they needed to go. I underappreciated the speed with which the Fed was going to get us there.

Had inflation been lower, or had Russia-Ukraine not happened, perhaps the Fed would have had the opportunity to take 12 months to get to the neutral rate rather than six months. So, I definitely did not think about the 75-basis-point increases.

Having said that, front-loading like this makes a lot of sense. Monetary policy works with a lag of nine months to a year. You want to get to the neutral rate quickly and then hang out there for a long period of time. I think the idea right now that the Fed is going to overtighten and then have to start loosening right away is either a misinterpretation or wishful thinking.

I do expect the Fed may start decelerating the pace of tightening and then stop at whatever point it deems necessary, whether that’s in December, February, or March, and then just keep rates at that level for years.

Hugo: This equilibrium you’re describing is not inimical to investors such as ourselves, who are focused on quality growth, if we’ve got stable rates and a stable yield curve, and then enough growth in earnings to extract a decent total shareholder return. You might not get any help from multiples, but you’re not going to get any hindrance, either.

Olga: That’s exactly right. In fact, 2003 to 2007 was exactly that kind of expansion that you are highlighting. Rates had increased from something like 1% to over 5%. They were briefly higher than the 10-year rate. During that entire time, we saw very little derating, and the entirety of stock market returns was driven by earnings growth. That’s exactly what you would normally expect in an expansion. Where you get multiple reratings, where investors significantly increase their expectations for stock price multiples, is really only typically in recoveries—a very short but highly accretive period of time. An ordinary expansion is usually all about earnings growth, so this could be potentially very good for us. 

Hugo: Has the complexion of earnings growth this year been different from what you expected? Have some sectors grown their revenues more than you would have thought while other sectors disappointed?

The energy sector has had positive revisions, and the technology sector has had negative revisions. The levels of growth at the start of the year may well have been different between those two, but the rate of change, where we’ve seen more or less growth than you expected, might be surprising.

Olga: Again, we did not forecast the Russia-Ukraine conflict, and, therefore, we did not expect the massive uptick in energy prices. As a result, we did not expect the significant earnings growth out of the energy sector.

I was much less surprised by the downward revisions for the technology sector. In the second half of last year, it was already apparent that both nominal and real growth had topped. You could see it at particular companies, but it also was becoming increasingly obvious at the industry level where cohorts of companies over-earned in the pandemic. Growth was going to decelerate sharply to, if not pre-pandemic rates of growth, something a lot closer to it. That’s effectively what we saw play out.

If you recall, when thinking about our multiples, we were benchmarking things to 2019 levels, exactly to take into account the pandemic overearnings. That story has mostly played out—maybe not for every company, but that has largely been the case.

Hugo: OK, we’ve talked about interest rates, nominal GDP, earnings growth, and energy prices.

What about the dollar? By the way, Olga, why is the dollar called the dollar?

Olga: I don’t know. Let’s Google it. “Origin and history of the word ‘dollar’ and dollar sign.” This is very cool. It’s actually from University of Exeter on the history of money.

The dollar is an Americanized or Anglicized form of “thaler,” the name of a coin minted in 1519 in Bohemia, what is now effectively the Czech Republic.

How did they get from thaler to dollar? I’m not sure.

It’s only after Europe had secured enough LNG supply and begun to address its need for LNG import terminals that we are starting to see cracks in that story of dollar appreciation.

Hugo: Anyway, another manifestation of the strength of nominal GDP in the United States is the strength of the dollar—or the wrecking ball dollar, as we call it. That has reverberated around the world. Are you surprised by how persistently strong the dollar has been?

Olga: Yes and no. I am becoming more of a typical economist by the day; it’s terrible.

Because we did not forecast the Russia-Ukraine conflict and we did not expect an upsurge in prices of fossil fuels, especially gas, given the massive supply disruptions, we did not expect a much stronger dollar.

Once the war broke out, and once we saw by April or May that the cost to Europe of procuring energy was going to be two to three times higher than it had been used to, that’s where you saw a continued rapid appreciation of the dollar. It’s only after Europe had secured enough LNG supply and begun to address its need for LNG import terminals that we are starting to see cracks in that story of dollar appreciation.

Hugo: Final question. Are you surprised there hasn’t been a major credit event, given the sharp rise in interest rates and the strength of dollar? Or is the recent crypto implosion the credit event?

Olga: Well, we really won’t know until it’s over. Earlier in the year, we saw balance-of-payment difficulties in some of the frontier and more emerging economies, such as Sri Lanka. The Philippines, Pakistan, and Egypt are also experiencing difficulties of their own. Some of them have asked the International Monetary Fund (IMF) for help. At the time, everybody says, “Is this the credit event?”

Now we have the crypto implosion, and this may prove to be the credit event. We saw a non-negligible selloff in the gilts market in the United Kingdom. You know this all too well, living in London. Was that the credit event? These are all relatively small and isolated. These are not systemic events.

Hopefully this will be it, or there will be a series of similarly small and contained events. But we really won’t know until the Fed is truly well and done tightening.

Olga Bitel, partner, is a global strategist on William Blair’s global equity team.

Hugo Scott‐Gall, partner, is a portfolio manager and co-director of research on William Blair’s global equity team.

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The post Lessons From a Chaotic Year appeared first on William Blair.

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Stay Ahead of GDP: 3 Charts to Become a Smarter Trader

When concerns of a recession are front and center, investors tend to pay more attention to the Gross Domestic Product (GDP) report. The Q4 2022 GDP report…



When concerns of a recession are front and center, investors tend to pay more attention to the Gross Domestic Product (GDP) report. The Q4 2022 GDP report showed the U.S. economy grew by 2.9% in the quarter, and Wall Street wasn't disappointed. The day the report was released, the market closed higher, with the Dow Jones Industrial Average ($DJIA) up 0.61%, the S&P 500 index ($SPX) up 1.1%, and the Nasdaq Composite ($COMPQ) up 1.76%. Consumer Discretionary, Technology, and Energy were the top-performing S&P sectors.

Add to the GDP report strong earnings from Tesla, Inc. (TSLA) and a mega announcement from Chevron Corp. (CVX)—raising dividends and a $75 billion buyback round—and you get a strong day in the stock markets.

Why is the GDP Report Important?

If a country's GDP is growing faster than expected, it could be a positive indication of economic strength. It means that consumer spending, business investment, and exports, among other factors, are going strong. But the GDP is just one indicator, and one indicator doesn't necessarily tell the whole story. It's a good idea to look at other indicators, such as the unemployment rate, inflation, and consumer sentiment, before making a conclusion.

Inflation appears to be cooling, but the labor market continues to be strong. The Fed has stated in many of its previous meetings that it'll be closely watching the labor market. So that'll be a sticky point as we get close to the next Fed meeting. Consumer spending is also strong, according to the GDP report. But that could have been because of increased auto sales and spending on services such as health care, personal care, and utilities. Retail sales released earlier in January indicated that holiday sales were lower.

There's a chance we could see retail sales slowing in Q1 2023 as some households run out of savings that were accumulated during the pandemic. This is something to keep an eye on going forward, as a slowdown in retail sales could mean increases in inventories. And this is something that could decrease economic activity.

Overall, the recent GDP report indicates the U.S. economy is strong, although some economists feel we'll probably see some downside in 2023, though not a recession. But the one drawback of the GDP report is that it's lagging. It comes out after the fact. Wouldn't it be great if you had known this ahead of time so you could position your trades to take advantage of the rally? While there's no way to know with 100% accuracy, there are ways to identify probable events.

3 Ways To Stay Ahead of the Curve

Instead of waiting for three months to get next quarter's GDP report, you can gauge the potential strength or weakness of the overall U.S. economy. Steven Sears, in his book The Indomitable Investor, suggested looking at these charts:

  • Copper prices
  • High-yield corporate bonds
  • Small-cap stocks

Copper: An Economic Indicator

You may not hear much about copper, but it's used in the manufacture of several goods and in construction. Given that manufacturing and construction make up a big chunk of economic activity, the red metal is more important than you may have thought. If you look at the chart of copper futures ($COPPER) you'll see that, in October 2022, the price of copper was trading sideways, but, in November, its price rose and trended quite a bit higher. This would have been an indication of a strengthening economy.

CHART 1: COPPER CONTINUOUS FUTURES CONTRACTS. Copper prices have been rising since November 2022. Chart source: For illustrative purposes only.

High-Yield Bonds: Risk On Indicator

The higher the risk, the higher the yield. That's the premise behind high-yield bonds. In short, companies that are leveraged, smaller, or just starting to grow may not have the solid balance sheets that more established companies are likely to have. If the economy slows down, investors are likely to sell the high-yield bonds and pick up the safer U.S. Treasury bonds.

Why the flight to safety? It's because when the economy is sluggish, the companies that issue the high-yield bonds tend to find it difficult to service their debts. When the economy is expanding, the opposite happens—they tend to perform better.

The chart below of the Dow Jones Corporate Bond Index ($DJCB) shows that, since the end of October 2022, the index trended higher. Similar to copper prices, high-yield corporate bond activity was also indicating economic expansion. You'll see similar action in charts of high-yield bond exchange-traded funds (ETFs) such as iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Barclays High Yield Bond ETF (JNK).

CHART 2: HIGH-YIELD BONDS TRENDING HIGHER. The Dow Jones Corporate Bond Index ($DJCB) has been trending higher since end of October 2022.Chart source: For illustrative purposes only.

Small-Cap Stocks: They're Sensitive

Pull up a chart of the iShares Russell 2000 ETF (IWM) and you'll see similar price action (see chart 3). Since mid-October, small-cap stocks (the Russell 2000 index is made up of 2000 small companies) have been moving higher.

CHART 3: SMALL-CAP STOCKS TRENDING HIGHER. When the economy is expanding, small-cap stocks trend higher.Chart source: For illustrative purposes only.

Three's Company

If all three of these indicators are showing strength, you can expect the GDP number to be strong. There are times when the GDP number may not impact the markets, but, when inflation is a problem and the Fed is trying to curb it by raising interest rates, the GDP number tends to impact the markets.

This scenario is likely to play out in 2023, so it would be worth your while to set up a GDP Tracker ChartList. Want a live link to the charts used in this article? They're all right here.

Jayanthi Gopalakrishnan

Director, Site Content


Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

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Hotels: Occupancy Rate Down 6.2% Compared to Same Week in 2019

From CoStar: STR: MLK Day Leads to Slightly Lower US Weekly Hotel PerformanceWith the Martin Luther King Jr. holiday, U.S. hotel performance came in slightly lower than the previous week, according to STR‘s latest data through Jan. 21.Jan. 15-21, 2023 …



With the Martin Luther King Jr. holiday, U.S. hotel performance came in slightly lower than the previous week, according to STR‘s latest data through Jan. 21.

Jan. 15-21, 2023 (percentage change from comparable week in 2019*):

Occupancy: 54.2% (-6.2%)
• Average daily rate (ADR): $140.16 (+11.3%)
• evenue per available room (RevPAR): $75.97 (+4.4%)

*Due to the pandemic impact, STR is measuring recovery against comparable time periods from 2019. Year-over-year comparisons will once again become standard after Q1.
emphasis added
The following graph shows the seasonal pattern for the hotel occupancy rate using the four-week average.

Click on graph for larger image.

The red line is for 2023, black is 2020, blue is the median, and dashed light blue is for 2022.  Dashed purple is 2019 (STR is comparing to a strong year for hotels).

The 4-week average of the occupancy rate is below the median rate for the previous 20 years (Blue), but this is the slow season - and some of the early year weakness might be related to the timing of the report.

Note: Y-axis doesn't start at zero to better show the seasonal change.

The 4-week average of the occupancy rate will increase seasonally over the next few months.

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American Express Numbers Show What Still Gets People to Spend Money

American Express stock jumped nearly 12% since earnings dropped.



American Express stock jumped nearly 12% since earnings dropped.

Even though American Express  (AXP) - Get Free Report earnings announced Friday afternoon fell somewhat short of expectations for the quarter, shares still soared to highs unseen for many months due to a number of strong metrics -- quarterly revenue growth of 17%, plans to raise its dividend by 15% from 52 to 60 cents and an annual revenue that surpassed $50 billion for the first time ever.

At $52.9 billion, the latter is driven primarily by an increase in quarterly member spending. Last year, that number was at $42.4 billion. 

According to American Express Chairman and CEO Stephen J. Squeri, the increase can be attributed to higher numbers of millennials gaining in earning power and using their AmEx above other cards to tap into rewards as many approach milestones like marriage, career advancement, and homeownership.

"Millennial and Gen Z customers continue to be the largest drivers of our growth, representing over 60% of proprietary consumer card acquisitions in the quarter and for the full year," Squeri said in an earnings call discussing the results.

People Are Using Their AmEx Cards a Lot

The $52.9 billion number is up 25% from what was seen last quarter and reflects a number of different factors also having to do with post-pandemic spending.

"We ended 2022 with record revenues, which grew 25% from a year earlier, and earnings per share of $9.85, both well above the guidance that we provided when we introduced our long-term growth plan at the start of last year, despite a mixed economic environment," Squeri said.

AmEx further reported that 12.5 million new members signed up for cards in 2022 while existing members used their cards frequently. Fourth-quarter sales at AmEx's U.S. consumer services and commercial segments rose by a respective 23% and 15%.

But higher expenses also led to falling below analyst expectations. The fourth-quarter income of $1.57 billion, or $2.07 a share, is down from $1.72 billion ($2.18 a share) in the fourth quarter of 2021. FactSet analysts had predicted $2.23 a share.

"I'm not sure what that's really a function of right now -- whether it's a function of the economy or of confusion on where to advertise right now," Squeri told Yahoo Finance in reference to lower spending on the part of small business and digital advertisers. "We're going to watch that, but the consumer is really strong, travel bookings are up over 50% vs pre-pandemic."


It's a Good Time to Be Tracking Credit Card Companies

Immediately after the earnings dropped, AmEx stock started soaring and was up nearly 12% at $175.24 on Friday afternoon. This is a high unseen in months -- the last peak occurred when, on September 12, shares were at $162.45. 

Whether due to or despite analyst threats of a looming recession, people have been using their credit cards very actively throughout the end of 2022.

When it posted its earnings earlier this week, Mastercard  (MA) - Get Free Report surpassed Wall Street expectations of $5.8 billion and $2.65 per share in fourth-quarter earnings. Visa  (V) - Get Free Report also saw revenue rise 11.8% to $7.94 billion in the same quarter. The numbers also reflect higher numbers of people traveling and using their credit cards in different countries.

"Visa's performance in the first quarter of 2023 reflects stable domestic volumes and transactions and a continued recovery of cross-border travel," outgoing CEO Al Kelly said of the results during a call with financial analysts.

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