What I Care About This Week | 2022 May 2

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Photo by Ian Turnell on Pexels.com

by Franklin J. Parker, CFA

The Summary

  • A big week this week, both in data and policymaking. The Federal Reserve meets Tuesday/Wednesday, meaning that on Wednesday we likely get an interest rate hike as well as a press conference from chairman Powell. Currently, the expectation is a rate hike of half a percent, but investors are watching very closely for how the Fed will manage its balance sheet on an ongoing basis. At present, they are allowing $95 billion/month to mature. Changes to that figure or strategy will be important developments. Of course, how Powell speaks to the ongoing inflation problem will be important, as well.

  • Today we got the purchasing manufacturer’s index (PMI), which posted at 55.4—significantly lower that the 57.5 that was expected. While this is still signaling expansion (anything above 50 is expansion), it has slowed considerably over the past months. Tomorrow we get data on factory orders and job openings, and Friday we get the unemployment rate for April. With worry over an economic slowdown growing, all of this data could be market-moving.

  • Speaking of economic slowdown, shocking news last week on GDP growth which posted a 1.4% contraction for the first quarter of 2022. The economy, it turned out, shrank last quarter. The definition of a recession is two quarters of contraction, so that is half of the equation. Naturally, this has spooked investors. As I have mentioned before, I do not see a recession as likely for this year, but it does appear that one is forming in 2023. This means that I see this pullback as a buying opportunity. The data is changing quickly, however, and flexibility is key in this environment.

The Details

I have had several conversations over the past few weeks about whether the US dollar can maintain its global prominence. The concern is understandable—most of us have never lived in a world without US dollar hegemony—and with the recent weaponization of the dollar, and its questionable ongoing management, there are good reasons to be concerned.

The main thrust of my counterpoint can be seen in the chart below. Generally speaking, the more a country exports, the more foreign reserves it will tend to hold. This makes sense: when China sends goods to the US, Chinese companies receive dollars and US companies receive goods. Export-driven economies, then, will tend to have large amounts of foreign reserves on hand—because they are constantly receiving foreign currencies. Import-driven economies tend to have the opposite—they tend to have little in the way of foreign currencies because they are importing goods, not cash.

And this is the primary reason why the US dollar is the global reserve currency: for decades, the US has been the largest importer in the world (though this has recently shifted to China). This means that US dollars are flung all over the world, making it quite easy for Japan to buy goods from Korea with US dollars, because they both have them already. The Indian Rupee, by contrast, is localized mostly to India because India is an export-driven economy and it is relatively difficult for other countries to get ahold of.

Before another currency can be the global reserve currency, it has to be accessible by people around the globe. A global reserve currency, then, will most likely be backed by an import-driven economy.

I am, therefore, a bit more bullish on the US dollar than most seem to be. Other than the Euro, which is another import-driven currency, the dollar is the easiest currency for most people to get their hands on. Until and unless another country imports more than the US (and uses their own currency to purchase those imports), it is unlikely that the dollar’s dominance will wane.

Chart of the Week

Last week we also got earnings from the FAANG crowd. Amazon’s considerable loss was a surprise—analysts expected a profit of $8.35 per share and Amazon posted a loss of $7.56 per share. Netflix was another shocker: for the first time in over a decade, Netflix lost subscribers. The bright spots were Tesla, which saw its margins expand due to higher prices—deliveries where about equal to last quarter—and Apple, which saw profits much higher than expected. Apple, however, issued concerning guidance on inflation and supply chain problems.

It is also worth noting that these companies have been the innovators in the US economy for some time now, and in a world with rising interest rates, innovation is becoming more expensive. In fact, over the past year, technology stocks have tended to deliver lower returns as interest rates rose, and higher returns as rates dropped, as this week’s chart shows. That is a trend likely to continue, and this creates a headwind for the sector as a whole and for new companies looking to launch a disruptive product or service.

There is some hope that more expensive innovation will put the focus on quality instead of quantity. Investors should be cautious going forward: the days of “easy” returns are behind us. Upside will be hard-won going forward, and a focus on quality is more likely to be rewarded.

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