What Year Is It? Tech Outlook for 2022

This is a shortened version of the Grit Capital Newsletter.

While the decimation of spec tech has dominated headlines, there have been two industries that have not only escaped the sea of red but have been thriving in the chaos: Energy and Financials.

Amidst all the doom and gloom, we have to remember that the S&P500 is only down 8% from all-time highs. As much as it seems like as goes megacap tech, so goes the market, that is not always the case.

This week, in <5 minutes, we’ll cover the Energy and Financial value plays:

  1. Macro Backdrop
    Rising rates combined with high growth and inflation
  2. Cyclical vs. Defensives
    How each are expected to perform in different market conditions
  3. A Note on Correlation
    Industry correlations with rate movements
  4. Financials as an industry
    Why rates matter
  5. Energy as an industry
    I thought Oil was in secular decline?
  6. Here for a good time? or a long time? Looking at current price action and multiple expansion

1. Macro Backdrop
Rising rates combined with high growth and inflation

When you have inflation run amok, the Fed has to step in, and market economists are now pricing this in, to the tune of 4 rate hates (25bps each = +1%) in the current year. But there is a very divided camp on the longevity of inflation, its impacts, and where rates can go from here.

We know they’re going up - but the uncertainty in magnitude and longevity that is currently being priced into the market is crushing growth stocks. If the market hates one thing it's uncertainty, and there’s plenty to go around right now.

2. Cyclical vs. Defensives
How each is expected to perform in different market conditions

What we essentially get from an economy throughout its growth period are mini cycles within “the cycle.” These mini cyclical waves ebb and flow but the general trend is up and to right as productivity growth prevails as the dominating long-term factor.

3. A Note on Correlation
 

When trying to understand grand ideas - you have to have knowledge of how the underlying subsectors react to macro events. One way to do this is to look at historical correlations between movements and stock price action. Correlations are never perfect because nothing ever happens in a vacuum, and there are far more variables at hand that can ever be fit into linear regression equations.

4. Financials as an industry
Why rates matter

When the FOMC acts to increase the federal fund rate, it creates a ripple effect throughout the economy. Since the benchmark rate is the federal fund rate, any increase in this will elevate all short-term borrowing costs for financial institutions.

Since these institutions have to then go out and lend this money to consumers (through anything from credit cards, mortgages, etc…), a majority of this is passed on to businesses and end consumption of goods and services.

5. Energy as an industry
I thought Oil was in secular decline?

After a prolonged period of lagging the market, energy stocks have moved into deep-value territory. When the industry is viewed to be in secular decline and a wave of ESG criticism come to the forefront, capital shies away from these equities.

But there comes a point where cheap is too cheap. When flows came out of growth, they went into value, and the rotation has been violent.

6. Here for a good time? or a long time?
Looking at current price action and multiple expansion

When you have Microsoft trading cheaper than Costco COST, and Google trading cheaper than Coca Cola KO (on a P/E basis), the runup in value starts to almost declassify these stocks as value stocks.

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