Notable

• The average price of all eggs, as calculated by the Consumer Price Index, has risen by 79 percent since January 2020. More specifically, the price of a dozen large, Grade A eggs rose 120 percent (from $1.93 to $4.25) in 2022 alone. This drastic increase is primarily due to an outbreak of avian influenza and has led to the death of about 58M birds, the deadliest outbreak on record.

Source: Chartr. 2023. “What’s In Your Basket? Eggs Are Topping The Inflation Charts.” Chartr newsletter, January 25, 2023.

• KB Homes, the sixth largest home builder in the US, reported a cancellation rate of 68 percent in the fourth quarter—worse than the industry’s 2008 cancellation rate of 50 percent. At the same time, some homebuilder stocks are at 52-week highs. There appears to be a severe disconnect in the industry.

• The International Energy Agency (IEA) projects global oil demand will reach a record high of 101.7M barrels per day in 2023—1.9M barrels per day higher than 2022. According to the IEA, almost half of this growth will come from China, whose stringent Covid restrictions have been lifted.

• Wages aren’t keeping up with inflation. Real average hourly earnings have now declined for 21 straight months, as inflation continues to outpace wage gains. This trend, together with other data points, raises a key question: When will the consumer rein in spending? Consumer spending resilience is especially surprising considering that in 20 states, the minimum wage is just $7.25 per hour (the federal minimum wage).

• Companies spent over $1 trillion in share repurchases in 2022, more than ever before. Many banks, including Goldman Sachs, predict corporate buybacks will decline by roughly 10 percent year over year in 2023.

Company Highlights

• Johnson & Johnson (JNJ) – It is the end of a J&J era. New-ish CEO Joaquin Duato was named Chairman of the Board, taking the reins from longstanding former CEO and Chairman, Alex Gorsky, who successfully led J&J for roughly a decade. Mr. Duato is only the eighth person to serve as both Chairman and CEO, a tremendous vote of confidence by the company’s Board of Directors as he leads the spin-off of the consumer health business and the revitalization of the MedTech business.

• Proctor & Gamble (PG) – The pace of innovation in consumer staples companies is often comical when contrasted with the rapid innovation cycles seen in tech and healthcare companies. However, P&G’s recent efforts to advance its products led to a new Cascade dishwashing detergent described as the “biggest formula upgrade in a decade.” The company reportedly tested over ten prototype formulations and over 13,000 test pods.

• Apple (AAPL) – Reports indicate Apple is planning to replace its outsourced iPhone chips, currently manufactured by Qualcomm and Broadcom, with its own chips in 2024-2025. We think this vertical integration will strengthen Apple’s competitive advantage by (1) further differentiating its products and (2) encouraging increased adoption of its ecosystem.

• Microsoft (MSFT) – Microsoft is reportedly considering a $10B investment in OpenAI, the company which recently launched ChatGPT (the popular chatbot powered by artificial intelligence (AI)). The investment would value OpenAI at roughly $30B. Microsoft views AI as integral to the future of its search engine, Bing; often overlooked, Bing’s revenue was $8.5B in 2021—close that of Snapchat and Twitter combined ($9.2B). Microsoft may also incorporate an AI chatbot into its Microsoft Office suite.

• Amazon (AMZN) – Amazon continues to roll out its distribution-as-a-service offering, Buy with Prime. The service allows e-commerce merchants to (1) offer Amazon Prime as a purchase option on their websites and (2) leverage Amazon’s streamlined (and familiar) checkout, fast and free delivery network, and easy return processes. Results from Buy with Prime’s initial pilot show that shopper conversion rates increase by 25 percent when Buy with Prime is offered.

• Microsoft, Amazon, and Alphabet (GOOGL) – Tech layoffs are garnering headlines and often feature Microsoft, Amazon, and Alphabet as poster children for the sweeping workforce reductions. During the pandemic, these three companies experienced sizeable increases in demand, and their prospects for future growth spiked also. In response, they rapidly increased their workforces. The macro environment has changed, though, and the now cost-conscious companies have announced large layoffs: Microsoft will cut its staff by 10,000 (or 5 percent), Amazon by 18,000 (or 1 percent), and Alphabet by 12,000 (or 6 percent).

On Our Minds

Not Out of the Woods Yet: 2023 May Be Another Challenging Year for Financial Markets

Last year was one for the history books. The S&P 500 index declined by more than 1 percent on 25 percent of trading days, the most since 2008 (which recorded drops on 29 percent of trading days). In an analysis of all S&P 500 annual returns since 1962, 2022’s ranked in the fifth percentile. And the Nasdaq’s return—the worst since 2002—ended the Nasdaq 100’s 13-year streak of positive returns.

What made 2022 even more difficult? The lack of safe places for investors to hide. Last year was just the third time since 1926 that both US stocks and bonds lost money in the same year; the US 10-year Treasury bond’s annual return was, in fact, the worst on record. Inflationary pressures, building in 2021, surged in 2022: the consumer price index (CPI) reached 9.1 percent in June, the highest level since 1981. In response to these pressures, the Federal Reserve (Fed) engaged in the fastest rate hike cycle in history to tighten financial conditions, as we detailed in June, August, September and November.

Statista. 2022. “The Fed Is Moving Historically Fast to Tame Inflation.” December 15, 2022. https://www.statista.com/chart/28437/interest-rate-hikes-in-past-tightening-cycles/.

If “unprecedented” was frequently used to describe 2020 and 2021, when companies had to manage the unique challenges of the global pandemic, “uncertain” is the adjective of choice for 2022 and 2023. As we approach the end of January and the fourth quarter earnings season, the outlook is exactly that—uncertain.

Whether the US will slip into a recession (or is already in one) remains a hotly debated topic. One key leading indicator of a recession, the yield curve (the difference in yield between the US 10-year and 2-year bonds), suggests we will. The last eight recessions in the US were preceded by yield curve inversions; in 2022, the yield curve not only inverted but subsequently declined to a whopping (85.2) basis point inversion in early December. (For context, the last time this curve inverted to a similar level was in the early 1980s, when inflation was above 10 percent. Even the yield curve inversion that preceded the Great Financial Crisis (the longest recession in history) reached a maximum inversion of just (19) basis points.) For more on yield curve inversions and other leading economic indicators (LEIs), see our October Reflections and Observations.

Other LEIs, such as negative GDP growth, also suggest a recession is likely: the US experienced two consecutive quarters of negative GDP in the second half of 2022. (The last recording of two consecutive quarters of negative GDP without a recession was 1947.) And yet, plenty of conflicting, data-driven signals from the real economy suggest the US may be stronger than we think. The labor market’s endurance, for example, is surprising for a recessionary environment, and recent data points suggest inflationary pressures may be subsiding.

What does this mean for financial markets? The S&P 500 has had back-to-back “down” years only four times in history; unfortunately, most of those periods— specifically 1929, 1973 and 2000—mirror present circumstances more than we’d like, with rising federal fund rates and the subsequent onsets of recessions. While the likelihood of a recession remains debatable, it seems clear the Fed intends to continue increasing rates and tightening financial conditions. Last year was tough, but 2023 presents its own set of challenges. If history repeats itself, it may well be another difficult year for equity markets. In the face of this uncertainty, we remain committed to our investment strategy and our long-term investment horizon and as a result are optimistic about the future.