Economy Holding Up Despite Rising Rates

The Dow and S&P 500 opened lower this morning (Dow -155 points; SPX -.9%). Commodities are trading broadly lower (gold -2%; copper -1%; oil -3.5%). Bond prices are in the red as well, allowing yields to rise along with interest rates. The 30-yeaar fixed mortgage rate just touched 6.2% for the first time since October 2008. Every asset class—stocks, bonds, commodities, real estate, crypto—has seen elevated volatility this year.

US retail sales were resilient in August despite high inflation. The Census Bureau’s survey confirmed that lower gasoline prices allowed people to shift spending toward other items (i.e. autos, furniture, health & personal care products). Sales grew 9.1% from year-ago levels, mostly reflecting 8.3% inflation. So “real” spending adjusted for inflation is something less than 1%, but as Bloomberg News puts it, “the report suggests consumer spending is far from collapsing.”

Adobe Systems (ADBE) tumbled 17% this morning after announcing a $20bil acquisition of Figma, a collaborative software developer. Figma competes directly against Adobe in software used to develop mobile apps. Management is thinking long-term with this deal, but the stock market just isn’t in the mood for that sort of thing. In addition, it looks like Adobe might be over-paying. Figma was valued at $10bil back in 2021 and even that price tag seems aggressive if you try valuing Figma as a multiple of sales or profits (or anything else). Separately, Adobe reported August quarter results, which were solid. Revenue grew by 13% and profits rose 9% from year-ago levels. Cashflow remains strong and the company’s products remain popular. Unfortunately, however, management warned that foreign exchange trends will dent profits for the current quarter. On one hand, today’s steep selloff might be overreaction seeing as how the stock is more than 50% below its 2021 peak. But on the other hand, this is not the time to disappoint investors, who are already sour-faced.

Famed bank analyst Mike Mayo, who changes firms like he changes shirts, says bank stocks are “out of sync” with their fundamentals. That is, they’ve been unfairly punished by investors who are afraid of coming recession. “If there is a recession, it is not affecting the banking industry, at least not yet.” The primary concern with a bank heading into recession is deteriorating credit quality—loan delinquencies. But Mayo points out that credit remains strong. The number of loans 30 days past due is near all-time lows. In addition, even if credit worsens the banks are well capitalized and can handle it (unlike during the Great Financial Crisis). In a note to clients he recommended Bank of America (BAC), PNC Financial (PNC), and Regions Financial (RF). Bank of America stock is now trading below pre-Covid levels and its P/E ratio has fallen to 10 from 14 this year.

Research firm Evercore ISI upgraded its view of Netflix (NFLX), saying it will likely outperform over the next 12 months. Earlier this year the stock fell over 70% when subscriber growth tanked. But Evercore expressed confidence that Netflix will successfully solve its problems by introducing a free ad-supported service and figuring out how to prevent password sharing. The firm thinks shares can climb to $300 from $236. Considering the stock’s peak was $700, this seems like a low bar. I point this out because it illustrates the pendulum effect. When the economy is booming and investors are bullish, stock prices tend to climb too high (i.e. Netflix at $700). And when the cycle turns negative and investor sentiment crashes, stock prices tend to fall too far ($236).