Jarvis? Newsletter: Retail Looks Wrecked; Are Growth Stocks Bottoming?

Another week that felt like doomsday in the markets is in the books, but we continue to dig deeply for positive factors in select sectors. The broader market was down just a fraction of a percent this week, but it certainly felt worse as selling was fierce, especially on Wednesday this week.

For most of 2022, we have called this the “whack-a-mole” market. That means that when we see pockets of strength in sectors, they often quickly go “poof”. We saw this in financials early in the year and this week we saw this spread from consumer discretionary stocks to consumer staples stocks. This is unsettling, given that many investors regard as defensive allocations and had held up fairly well so far in 2022.

The big stories this week were the disappointing earnings reports out of two of the country’s biggest and most heavily owned retailers: Wal-Mart (WMT) and Target (TGT). Both retailers had decent results in terms of sales growth. However, profit margins came in far below expectations, as both management teams shared that they have not been able to pass along their higher cost of goods to their customers through higher prices. Again, inflation in the story that seems to be driving everything. The Federal Reserve has just started to be aggressive to tighten monetary policy in the form of higher interest rates the end of its bond buying program. We expect to see impacts like these in the coming months, as companies adjust to the changing environment.

All was not negative in the markets this week. We have started to see some buoyancy in small and mid-cap stocks, as evidenced by the outperformance of the Russell 2000 Index this week. Additionally, the beleaguered Ark Innovation Fund (ARKK) showed signs of life, gaining more than 10% in value over the last week. The change in momentum there leads us to ask the question: “are growth stocks bottoming?” We do think there is some evidence of bottoming in certain segments, particularly in technology and software, which we will address later in the letter.

Another place where we see fortunes beginning to change is in the bond market. As stocks have fallen for 7 straight weeks (!), investors have poured funds back into high quality bonds like treasuries and investment-grade corporate bonds. This has caused market interest rates to slow their rise. This change is notable, as the direction of interest rates which has been a one-way trade for most of 2022. In contrast, high yield bonds continue to struggle and we know that it will be difficult for the stock market to sustain any rally, as long as that is the case.

Even though things do feel difficult in the markets with this losing streak that feels like it has gone on forever, we do think there are some smart moves that investors can make to prepare for when the selling finally does stop. To learn more about where we see opportunity, both in the bond and the stock market, sign up for a complimentary portfolio review or set a meeting directly on my calendar.

Make sure to watch this week’s Jarvis YouTube Update (and like, share, and subscribe!) CEO Noland Langford and I discuss more about the week’s turbulent market action and opportunities we see developing in the bond market. We also have the Left Brain Thinking podcast back in full swing covering topics concerning personal finance, so make sure to check that out!

Head to our website and sign up for our mailing list, so you can receive our weekly updates in your inbox every Saturday morning. We are running a special on our research service again this week, offering subscribers 8-10 full length stock reports each month. With another week of volatility, we’ve decided to extend our offer to new subscribers, who can access our basic subscription for $59/month for three months by navigating to our subscribe page and entering the promo code: Jarvis59 at checkout.

With that all being said, let’s get into it!

Below is the performance data of key indices, ETFs for the five trading days between 5/13/22 and 5/19/22:

What is/is not Working?

The basis of our “What’s Working?” and the “What’s Not Working?” segments in our newsletter is our Jarvis securities evaluation system. We use patterns we see in the data to identify pockets of strength and weakness.

As we alluded to at the top of the letter, market leadership did an “about face” this week. Many of the “risk on” sectors that had struggled for most of this year showed pronounced strength this week and the moves were outsized. The strength of the moves leads us to wonder whether this is short covering or fresh buying, but only time will tell.

The strongest performer in our ETF list this week was by far the Invesco Solar ETF (TAN), which rose an eye-popping 17.12% in value. We also saw double digit moves out of ARK Innovation ETF (ARKK), the First Trust SkyBridge Crypto Industry and Digital Economy ETF (CRPT), and KraneShares CSI China Internet ETF (KWEB).

We saw additional strength in other “risk on” sectors like The Emerging Markets Internet & Ecommerce ETF (EMQQ), Renaissance IPO ETF (IPO), SPDR S&P Semiconductor ETF (XSD), and ETFMG Alternative Harvest ETF (MJ).

It seems no matter what happens, however, energy remains a strong performer. This week, four of our top 20 ETFs came from that sector, including pipeline-focused ClearBridge MLP and Midstream Fund Inc (CEM), United States Natural Gas Fund, LP (UNG), and Invesco S&P SmallCap Energy ETF (PSCE).

We will examine this in more depth in a later section here, but consumer staples stocks were, by far, the worst performing sector in worldwide markets. The Consumer Staples Select Sector SPDR Fund (XLP) was the worst performing ETF, losing more than 6% in value this week as investors expressed concern about the impact of inflation on these companies that comprise the index.

Despite the fact that interest rates continued to fall over the last week, another clear pocket of weakness was in the municipal bond space, as the Pimco Municipal Income Fund (PMF) fell by nearly 6% this week. We aren’t ready to recommend a buy for municipal bonds quite yet, but they are starting to become more attractive, as the rates of interest they pay continue to rise as the price of the bonds fall.

Consumer Stocks Weak in the Knees

For those of you that didn’t get a chance to read about the earnings reports from Wal-Mart (WMT) and Target (TGT), we want to fill you in on what those companies communicated. The reason is that not only these stocks, but also the overall market sold off so sharply after these reports surfaced this week.

In the case of WMT, the company beat analyst estimates for revenue by more than $3.5 billion, but the earnings per share (EPS) figure of $1.30 badly missed expectations. Gross margins were down significantly, compared to those from fiscal year 2021 and there were a number of factors at work that led to the disappointing result. Inflation was the culprit in all three cases, with costs increasing in (1) wages, (2) cost of product, and (3) freight and fuel costs.

TGT had a similarly bad quarter and the stock has fallen by more than 30% since the earnings report came out on Wednesday morning of this week. Just like Wal-Mart, Target exceeded expectations from the total revenue point of view, but missed profit estimates by a wide margin. The company’s revenue rose by 4% Year-over-Year, but its cost of sales increased by 10%, putting a huge damper on profit margins. As a result, net income was down by around 50%, when compared to the same period in 2021. Investors had been expecting less profit than in the halcyon days of 2021, but this miss was a huge surprise. For the year 2022, we can basically cut profit estimations in half for this business, which certainly explains the dramatic move in the stock price.

These disappointing earnings results had ripple effects all through the consumer sector, as investors begin to mull the question of whether any stocks related to the consumer will perform in 2022. Consumers are clearly squeezed with higher food and gasoline prices and those businesses that cater to the consumer face similar pressures on their end, from the cost point of view. Whichever way you slice it, this seems like a bad combination for anyone invested in any consumer-related businesses.

The consumer staples sector has been one of the best producing throughout 2022. The thought behind that is that despite inflation, consumers have very little choice but to consume goods from the food and consumer products industries. Coming into this week, the Consumer Staples Select Sector SPDR Fund (XLP) was essentially flat on the year, which is a clear outperformance when compared to the more than 16% decline in the S&P 500 for the same period. The rethink that seemed to occur after the poor WMT and TGT reports hit this sector especially hard over the past week, with the XLP down nearly 7% in just one week. Among the stocks that we follow that took major hits this week were Kraft Heinz (KHC), PepsiCo (PEP), and The Hershey Company (HSY). All three lost between 7-15% in value in the past week!

With these stocks all down significantly, we understand that investors may be tempted to fade the declines in these stocks. We would caution investors to think twice before doing so. Our experience, so far in 2022, is that post-earnings declines have been anything but a “one and done” event (think Netflix (NFLX)) and that investors are only beginning to digest what is going on with the consumer. “Wait and see” has been the right approach for most of the beginning of 2022 and nothing tells us that should change in the near term.

Signs of a Bottom in Growth?

Let’s be honest with each other: the Ark Innovation Fund (ARKK) and the holdings therein have been absolute value destroyers in 2022. It is with good reason: most of the stocks in that fund are in the pre-profit stage and Mr. Market has been punishing these types of stocks with almost no regard.

But something appears to have changed this week. As we mentioned above, ARKK was up by more than 10% over the last week of trading. We saw impressive weekly returns coming from a number of companies either in the Ark ETF (or adjacent to that hypergrowth world).

All of this has us wondering if something different seems to be happening this week and we are asking the question “are growth stocks bottoming?” As the overall market was flat to weak, the growth stocks drew in significant buying. There is certainly a question of whether this represents short covering (these stocks were among the most heavily shorted on Wall Street) or if we saw fresh buyers coming in this week. We will have to watch how these stocks perform over the next week to determine the nature of the move here.

Examples of the phenomenon of outstanding performance among the most downtrodden stocks:

·????????SoFi Technologies (SOFI) up 40% in 5 days

·????????Draft Kings (DKNG) up 26%

·????????Roblox (RBLX) up 24%

·????????The Trade Desk (TTD) up 22%

·????????Robinhood (HOOD) up 22%

Take a brief look at the ARKK chart on a year-to-date basis. We can see the obvious downtrend in evidence there, but the chart begins to kick up with this week’s move:

For some of these stocks, we find it hard to stomach the idea of entering positions, especially in the current environment. But you can be sure that we are going to be monitoring them closely in the next few weeks to see if the momentum continues to develop.?There are a few signs we will be looking for a bottom, but let us be absolutely clear, we are not there yet:

1.??????We need to see yield spreads in the high yield bond market stop widening

2.??????Erratic market moves need to become the exception, not the norm

3.??????New market leadership needs to emerge.

High growth tech stocks are historically the best stocks to hold when the business cycle does finally turn. This is precisely why we are watching ARKK so closely because we are watching to determine when and whether those stocks regain leadership. It’s far too early to tell at this point.

Takeaways from this Week

Market action was clearly weak. The weakness centered on consumer related stocks, both in the discretionary space and in consumer staples, which had been one of 2022’s strongest sectors. In a bear market, eventually every sector will feel the brunt of the selling and this week we learned that consumer defensive was no exception.

We saw some of the early signs that hypergrowth tech might be bottoming, though it is much too early to tell. We did share with you the factors we will be looking for at a market bottom, when the selling does finally stop. We continue to sharpen our pencils here at Left Brain, making a shopping list of both stocks and bonds on a “Bounce Back” list that we think will perform best when the time finally does come again to play offense.

We hope the newsletter helps you make sense of a difficult time in markets! Contact me directly at (630) 547-3316 or [email protected], with investment questions or if you would like to discuss your current portfolio. Please make sure to take advantage of our $59/month offer for new subscribers using promo code: Jarvis59.

Thanks again for your continued support of the Jarvis Newsletter.

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