Markets notched a win for the week as third-quarter earnings season kicked off strong with banks and we are starting to exit a seasonally weak period of end of October. Reflecting on this week’s macroeconomic updates and earnings releases, we are left with the view that the economy continues to rebound as vaccination rates continue to rise and new COVID cases are on the decline.

A quick look at some of the broader market measures that we like to keep an eye on: we see the dollar index is hovering around the 94 level, gold is trading around the mid-$1700s level, WTI crude prices are holding in the low-$80s per barrel region and 10-year Treasury yields have advanced to the mid-1.5% range.

Within the portfolio we heard from Morgan Stanley (update here) and Wells Fargo (update here), both of which delivered solid quarter, initially got dinged by the market (as usual) but reversed the loss entirely, showing incredible strength. In addition to the start of earnings season, we received several key macroeconomic data points this week that provide insight into inflationary dynamics and that when combined with bank earnings, the current state of the consumer.

Inflation peaking?

Taking a look at the broader economy, on Wednesday, we got the September consumer price index (CPI), which measures the price to consumers for a basket of goods. On a seasonally adjusted basis, the headline reading indicated a 0.4% advance in September, hotter than the 0.3% investors were expecting. Contributing to the headline reading, the food index rose 0.9%, with the food at home index increasing 1.2%, while the food away from home (not seasonally adjusted) increased 0.5% in September. Additionally, the energy index increased 1.3%, with the energy commodities index advancing 1.3% and the energy services index increasing 1.2% for the month. That monthly advanced resulted in a 5.4% annual increase, an acceleration from the 5.3% rate seen in the 12-month period ending in August.

CPI ex-food and energy, also known as “core CPI,” which many use as a proxy for inflation, came in at 0.2% in September, matching expectations and resulting in a 4.0% annual core CPI increase, the same rate of increase seen in the 12-month period ending in August.

The next day, Thursday, we got the producer price index (PPI) reading, which as the name implies, measures prices to producers for a basket of goods. This also provides hints into inflationary dynamics because when producer costs run too hot, they are forced to either eat the cost at the expense of profit margins, or pass those costs along to the consumer. The headline reading indicated a 0.5% advance for the month of September, less than the 0.6% consensus.

To a market which has been concerning about inflation, this update somewhat eased the fear for investors, with hopes that the rate of inflation could be peaking. According to the Bureau of Labor Statistics, we can attribute almost 80% of the advance to a 1.3% increase in prices for final demand goods, with the final demand services index increasing 0.2% in September. Annually, the PPI was up 8.6% in September, in line with expectations and marking the largest 12-month advance since the index was first calculated back in November 2010. Excluding food, energy and trade services (which “measure changes in margins received by wholesalers and retailers”), core PPI ticked up 0.1% in September, well below the 0.4% consensus. Annually, the core PPI index advanced 5.9%, below the 6.5% consensus and a notable deceleration from the 6.3% rate seen in the 12-month period ending in August.

Consumer is heating up:

Finally, on Friday, we got retail sales numbers that came in stronger than expected, rising 0.7% month on month in September versus expectations for a 0.2% monthly decline and compounded by an upward revision to August reading to up 0.9% (from +0.7% previously reported). Annually, retail sales advanced 13.9% from the same time last year, far exceeding the 9.4% consensus. If we take out automotive sales – which due to their high ticket price can increase monthly volatility and cloud the overall trend – retail sales advanced 0.8% versus a 0.5% consensus. Excluding auto and gas sales, retail sales advanced 0.7%, more than doubling the +0.3% the street was looking for.

Digging into the report a bit, on a monthly basis the largest advances were seen in sales at sporting goods, hobby, musical instrument, & book stores (+3.7%), general merchandise stores (+2.0%), gasoline stations (+1.8%) and miscellaneous store retailers (+1.8%) while there was some give back at electronics and appliance stores (-0.9%) and health and personal care stores (-1.4%). Annually the largest advances were seen at gasoline stations (+38.2%), food services and drinking places (+29.5%), clothing and clothing accessories stores (+22.4%) and, miscellaneous store retailers (21.4%).

So, on the macro front this week, looking at headline numbers, CPI was a tad above expectations, PPI a tad below expectations – a dynamic that hopefully points to inflation rates starting to peak – and a retail sales number that was red hot. 

Looking for pricing power stocks into year's end:

We received commentary from management teams this week during bank earnings conference calls that pointed to a consumer flush with cash. Wells Fargo CEO Charles Scharf said “leverage at its lowest level in 45 years and the debt burden below its long-term average.”

Ultimately our view boils down to an economy that is continuing to recover and grow. In addition to the cyclical or recovery stocks which directly benefit, we also like to diversify with secular growth technology names. Regardless, given the ongoing supply chain congestion and labor shortages that are causing the “transitory” inflation, we want to own names with strong pricing power that can pass higher costs through to their customer base in order to protect margins. We will get a better sense of which names have that ability as earnings season ramps up as we will get an updated look at operating margins and hear from management teams about their ability to pass through costs.

What we are watching:

Looking ahead, earnings season will ramp up next week with one portfolio company set to report, Nucor. Other earnings that will be monitoring (though are not current portfolio holdings) include:

Mon 10/18: nothing to comment

Tues 10/19:

Netflix (NFLX)

• Shares of Netflix have been outperforming the overall market recently, due to tailwinds from the blockbuster release Squid Game. Because market has already priced in a robust quarter with strong subscription numbers on such tailwind, so we don't like Netflix going into the quarter (we think very likely it will be a sell the news event). However if there's something new down the pipeline that can cheer investors on.   

United Airlines (UAL)

• Delta reported a positive quarter this week. Should be good for UAL. Also international travel will be back soon.

Wed 10/20:

ASML (ASML):

• This is a Dutch semiconductor manufacturer. We get another read on the status of the semiconductor shortage (think Ford). We also get another read on the semiconductor demand going forward (think AMD).

Tesla (TSLA)

• Tesla is going to have a blowout quarter, we can guess that from the slew of analysts raising their price target going into the quarter. We regret having sold the stock in the high 600s, missing out on this big move. However, we own our mistake and will not buy it here.

Thurs 10/21:

Intel (INTC):

• If Intel delivers a surprise beat, the stock will move up huge (duh). The problem is, the likelihood of that happening is very low.

Fri 10/22: American Express (AXP)

•  They will report the strength of consumer spending in the past quarter, which will serve as a forecast for how strong retailers' earnings will be. 

• Additionally, they will give us a look at inflation (data from restaurant/ goods spending).

• Lastly, they will tell us what they think about consumer strength going forward.

Portfolio Overview:

Amazon (AMZN): Shares of Amazon out-performed the market this week, up 3.66% on the week. Bank of America named Amazon a top e-commerce pick with expectations for the company to gain market share in the U.S. this year. When Amazon reports its quarterly results after the market close on Oct. 28, we'll confirm Bank of America's thought by comparing Amazon's U.S. retail results against the 7.5% year-over-year increase in non-store retail sales for the September-quarter revealed in the September retail sales report. As Amazon examines the current supply chain issues, reports suggest the company is looking to buy long-range cargo jets and hire associated flight crews that would allow the company to directly transport goods from China and other countries across the ocean.

Apple (AAPL): During the week, it was reported by Bloomberg that Apple would cut its iPhone 13 production by around 10% for 2021. Market initially dinged 2% off this stock in the pre-market, but eventually the stock recovered to ending the trading day flat. Apple ended the week up 1.36%, in-line with the market. We were happy with this reaction as this is sign for the market viewing Apple more as a service provider, rather than an equipment manufacturer. Additionally, soon after the report, foundry partner Taiwan Semiconductor reported robust sequential revenue for its smartphone business and lifted its overall revenue guidance for the current quarter, calming smartphone chip supply concerns. Apple will hold its next virtual event on Oct. 18, at which it is widely expected to debut new M1 Mac models and new Air Pods as well.  

Advanced Micro Devices (AMD): Shares of AMD strongly outperformed the market this week, up more than 6% and now sits near its all time high. During the week KeyBanc shared its view that while AMD will continue to benefit from cloud data center demand, supply constraints could limit meaningful gains in servers and PCs. That said, AMD foundry partner Taiwan Semiconductor reported a stronger-than-expected September quarter and boosted its outlook for the current one. AMD will report its quarterly results on Oct. 26 after the market close. 

Applied Materials (AMAT): This week we started a position in the shares of this semiconductor capital equipment company given the pain point in the automotive chip sector, but also continued demand for chips as 5G, AI, AR/VR, the connected car and IoT markets mature in the coming years. Since the addition we've seen a 5% gain in this position, however, we are willing to hold for the longer term. In the coming week, we'll be paying close attention to quarterly results from competitor Lam Research (LRCX). Applied's next $0.24 per share quarterly dividend will be paid Dec. 16 to shareholders of record Nov. 26. 

Salesforce (CRM): There was no company-specific news this week, however, Salesforce shares produced a 7% gain for the week and now sits at all time high.

Disney (DIS): Disney underperformed the market this week, still indicating that it is in a long-time consolidation zone of 170-180$. Disney was rumored to again be looking to unload ESPN in a potential spin-out, which could position the company's streaming efforts more closely with Netflix (NFLX). While we wait to see if any such transaction develops, we see the company's domestic parks benefitting from the U.S. allowing vaccinated travelers into the country starting Nov. 8. Disney will report its September-quarter results on Nov. 10. 

Ford (F): Ford outperformed the market this week, up nearly 4% and now back to June's high. However, this strong move comes amid negative news about the chip shortage, which actually suggests the sentiment for Ford and automakers has turned positive (we wrote about that here. Ford reported its 3Q 2021 sales in Greater China exceeded 150,100 units, representing a year-over-year decrease of 8.7%. The company once again announced it would suspend production on Oct. 15 at its Hermosillo plant in Mexico, which produces its higher-margin Bronco Sport SUV, because of material shortages. This follows similar closures on Oct. 11-12. The current auto chip shortage was named as a factor that led to European Union car registrations falling 23.1% to 718,598 units in September. That decline followed the 19.1% decline in August and 23.2% decline in July and marked the lowest number of registrations for September since 1995. While this will be a headwind to Ford's December guidance, we continue to focus on the longer-term opportunity with the shares, as the current turnaround strategy matures and the company's EV portfolio expands. We continue to monitor developments surrounding EV tax credits in Washington. 

Microsoft (MSFT): Shares of Microsoft performed in-line with tech companies this week, up about 3%, now sit at all time high (where is that correction?) The company announced it is shutting down the Chinese version of LinkedIn. Also this week, The U.S. Army confirmed it has delayed the fielding of Microsoft's augmented reality goggles, Integrated Visual Augmentation System (IVAS) until later in 2022. Estimates suggest that program could be worth up to $21.9 billion over a 10-year period. 

Nucor (NUE): Shares of Nucor has been recovering from recent sell-off, up nearly 4% this week, seemingly broken out of downtrend, but hit a key resistance. There was no company-specific news this week. We think shares of Nucor will trade in a sideways pattern until we hear more from management on Thursday next week, most importantly regarding forward guidance. Market needs to hear that the steel cycle is far from over (it's funny market never learns historical lessons, as in the past steel super cycles last for many years). Also Nucor is a name that will be under the influence of news from Washington DC regarding infrastructure package. 

Paypal (PYPL): Shares of PayPal outperformed the market this week, seemingly broken out of downtrend and now trying to reclaim the MA200. Paypal was once again named a standout in Cowen's Gen Z/Millennials Survey. Also, this week, the company inked a MOU with the Indian Institute of Foreign Trade to jointly launch the India Digital Trade Facilitation Forum from micro, small and medium enterprises. 

Morgan Stanley (MS), Wells Fargo (WFC): these two banks reported earnings this week, which we wrote about here and here. We reiterate these holdings and advice buy on dips for these banks as we head into 2022 with rate hikes.

Kinder Morgan (KMI): shares of secondary, mid-stream/ service energy companies (like Kinder Morgan or Schlumberger or Halliburton) finally have been catching bid, following the meteoric rise in the stocks of energy production& exploration companies that benefit directly from the rise in oil prices (think Diamondback Energy). In a week when energy production& exploration companies like Diamondback Energy, EOG Resources, Exxon or Chevron remain either flat or down slightly, oil services and mid-stream companies like Schlumberger or Halliburton were up around 7%. Kinder Morgan does not have as high of a beta as other companies (up only ~4%), so on the offense it may appear weak, but for a young portfolio manager which does not understand the movement of oil prices as well as they would like, we feel confident in owning and recommending shares of Kinder Morgan because of the nature of its operation (we write about it here). Regardless of oil prices, as long as demands stay strong, Kinder Morgan should benefit. Additionally, Kinder Morgan offers a premium dividend (more than 5%), an eyebrow-raising number that it is very hard to beat.