The strong US job market is one of the drivers of the strong inflation data. With a slowing job market we can expect a slackening of consumer demand. For the time being, the US consumer continues to show resilience in the face of higher prices.
The economy, both in the US, and even more so, outside the US is slowing. The US economy has stayed stronger for longer than many have expected forcing the Fed to raise rates faster than at almost anytime in history. For now, it seems the markets have been reacting to higher interest rates by heading lower as rates rise. Long duration treasuries are beginning to price in the economic slowdown. Earnings have held on better than many expected and have helped to buoy the market somewhat. But while almost all stocks are down, most large stocks, especially the old market leaders, still look overpriced if we start factoring in a significant global slowdown. Last week I highlighted a few well-known big caps that are trading at double digit PE ratios yet are growing revenues at single digits or in some cases shrinking revenues. The bigger stocks seem to be pricing in less of a slowdown than many smaller stocks I follow. I believe there is too much of a disconnect between the large caps and smaller caps. The big stocks still look expensive to me, and the smaller ones seem much cheaper. Regardless of where the economy goes from here the pricing mismatch looks appealing.
Earnings of these big stocks are likely to weaken as the economy slows. A higher US dollar is already starting to impact many large international players. These companies dominate the market and have a major influence over the exchanges. If they go down so will the exchanges. But will the same happen to microcaps that are already trading at historically low levels? Likely, yes but probably more for liquidity reasons not valuation reasons.
In the small universe of microcaps that I follow I’m noticing another interesting trend. Certain microcaps are holding up or performing much better than others. These are what I call the the blue-collar companies. Companies that make stuff that if you dropped it on your foot it would hurt. Companies that are capital equipment intensive, capital intensive. You’d think that in an environment of higher cost of capital (higher interest rates and lower equity prices) these companies and their stocks would suffer greater than capital light businesses but that’s not what I’m seeing.
I don’t spend a lot of time looking at big caps so I’m not fully aware how prevalent this trend is there. The industrial company heavy DOW is performing much better than the technology heavy Nasdaq.
A big reason why I think these stocks are doing better than most is because they’ve been out of favor for so long. The attention, and investment capital, has gone to the “capital light” businesses. SAAS offerings, software, ad-tech, fintech, ed-tech, ag-tech, you-name-it-tech, these companies were getting sky high multiples because they could easily scale and with almost unlimited growth, they were given high valuations. “Cash was trash” and cash flow generating companies weren’t as sexy as hyper growing, yet money losing companies. Remember Cathie Woods’ ARK Innovation fund? The “capital light” company dominated fund is down 79% from it’s high.