Postcards from the Florida Republic - Merry New Year's Edition, January 1, 2023

Postcards from the Florida Republic - Merry New Year's Edition, January 1, 2023

POSTCARDS FROM THE FLORIDA REPUBLIC

From the Desk of Garrett Baldwin January 1, 2023

Weekly Recap: It was an incredibly low-volume burn over the short holiday week. I took gains shorting Caesar’s Entertainment (CZR) and the Nasdaq 100 with calls on the PSQ. Aside from that, it was quiet. I was eyeing the SPY $382 call for Tuesday’s expiration at 3 pm on Friday, but the index went bonkers, and I missed the rally while watching 30 Rock. No need to force anything with funds set to allocate capital and momentum still negative.

Current Outlook: I’ll go with 3,250 on the S&P 500 for the end of 2023. Valuation compression gives way to earnings compression as we start to witness the economic impact of Quantitative Tightening (QT). Cathie Wood continues to burn through other people’s money while frantically telling people to wait five years. The reality is that for some of these companies in Ark Innovation Fund’s portfolio, we might have to wait 17 years just for their stocks to get back to all-time highs. See Microsoft after the Dot-Com bubble as a prime example of what may come, even though that company was profitable for decades and had a monopoly in the software space. Tesla doesn’t have those advantages.

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Current Mood: "I’m writing a novel because it’s never been done before."

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Dear Future Florida Republic Residents,

Momentum has remained negative since the December 12 selloff began. I’ve largely avoided this negative cycle and sat on the sideline. The lack of volume in December was a pure sign that Santa Claus got hit by a bus returning home from the Fed meeting in mid-December. The Disney trip, the ensuing Disney flu, the Christmas holiday, and now New Year’s have me heading to New York City and Chicago for vacation and some relaxation.

I’ll largely be writing market commentary the entire week while trying to outline a novel.

I’ve got a bunch of people telling me that the S&P 500 will go back to 4,100 by the end of 2023. The average S&P 500 target on Wall Street is 4,009. That’s a 4.4% gain from Friday.

Unless the Federal Reserve engages in a soft default like what happened with the Bank of England earlier this year, these numbers are just not going to happen. There are still way too many people making downright insane macro calls right now who have never traded or invested in periods of higher interest rates, quantitative tightening (QT), or recession. I’ll be in New York and Chicago all this week, likely surrounded in Stone Street and Viagra Triangle bars by people in starter Men’s Wearhouse suits who have no knowledge of what happened in 2008-09, let alone 2001-02. I’m the bear – not because that’s my nature – but because I have studied the Federal Reserve’s impact on the market to a point of exhaustion.

My year-end target is 3,248.50. That’s 15.4% lower than Friday’s close at 3,839.50.

And I’m not talking about 3,248.50 as the low of the year. I fully anticipate a move under 3,100 and possibly in the range of 2,950. I’m expecting those last three months to be a so-called recovery – even though there will be selling into that move higher. It’s a trader’s market until the Federal Reserve pivots and moves to more accommodation once again.

I’ll keep this short because I just wrote a 3,000-word treatise earlier this week that will come out in Tactical Wealth Investor in five days. The argument centers on three factors.

1) The Fed’s move to 5% on its Funds rate will hurt equities, but not as much as the central bank’s moves to reduce its balance sheet by $1 trillion during this tightening cycle. There’s a direct causal relationship between the expansion and contraction of the Fed’s balance sheet and the performance of the S&P 500. The last tightening cycle in 2018 fueled a dramatic downturn in the final months of that year as the Fed finally pivoted. There are still too many unknowns about the Fed’s impact... but we do know that the central bank tends to break something significant during hike cycles. In fact, one could argue it’s already done so with certain emerging markets in need of IMF support, the Bank of England’s soft default, and even the FTX debacle.

2) There’s been a dramatic cooldown in corporate buybacks since Q2 2022. Yardeni Research suggests that buybacks were responsible for about 19% of the gains in the S&P 500 from 2010 to 2019. I must go back and find it, but I think there’s been something like $5 trillion in buybacks over the last 12 years. Now, that would suggest that the money just went away – but there’s a more conservative number that suggests maybe 10% of gains came from buybacks from a few years ago. Now that interest rates are rising, companies aren’t going to borrow money to buy back stock. Just do the math. You’ve got a Fed funds rate of 5%, and you’ll also have another 1% tax on buybacks added by a provision in the Inflation Reduction Act. It will be fascinating to see what Apple does in March after its historically large buyback programs. We should see a steep cooldown in buyback activity next year.

3) I’ve been reading this Grit Capital newsletter by Genevieve Roch-Decter. It’s pretty good. She was saying that unprofitable tech stocks had dropped 60% to 90% for 2022. She notes: “Taking a basket of high-growth software companies, they started the year off trading at an average of 35x EV/Revenue and now trade at 7x. That is a massive collapse of confidence in growth.” That’s all true. But that is just the first phase of this sort of market. The valuation compression was the story of 2022. Now, earnings compression is about to rattle this market hard. We’re still trading about 40% above the historical mean for the S&P 500 PE ratio. A move down to 15 times earnings or less is in the cards, like what happened back in 2018 during the Fed’s balance sheet reduction. That puts us down around 3,100, just at 15x. What happens if we test recessionary numbers like 12x? The Fed is still driving this market – and its policy is driving everything lower. It just won’t go straight down.

This will be a year for value stocks – and I’m already taking shots in the shipping sector because of the value and income that has been presented. It’s a bit odd to me that certain shipping stocks have secure dividends above 7% (not variable dividends) and are trading under their liquidation value. But that’s what happens in these macro-environments.

Who Wore It Better?

Sam Bankman-Fried is back in the United States. He flew back first class on American Airlines, and I’m stunned that a football didn’t magically fly out of the coach section, bounce off the windowpane, and hit him square in the groin. That said, which “alleged” criminal do you think wore a black beanie better?

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He posted a $250 million bond last week – which is comical – because it’s basically just a promise that he will pay that figure if he doesn’t show up for court.

This is the largest ever pretrial bond... and one that should be larger given his charges of wire fraud, money laundering, and violating campaign finance laws.

Remember, SBF is out on bond... not bail. There’s a huge difference.

When someone has a bail hearing, they typically must put up 10% to 15% of the required payment. In this case, SBF would pay about $37.5 million to a bail bondsman to walk out of court. But that didn’t happen.

I’m reading reports that SBF simply signed a Personal Recognizance Bond - which contains his “fingers crossed, pinky swear, with sugar on top” promise - that he’d pay the $250 million to the court if he doesn’t show up to the trial on time. The court allowed his parents to put up their $4 million home as collateral.

Under the terms of his release, he will remain at his parents' house. All the time, remember, we have to say he is an “alleged” fraudster until he is convicted - or else I expose myself to force retractions and lawsuits. Isn’t America’s justice system insane?

Where Is the Value, Garrett?

This is all straightforward. Now is not the time to be thinking long-term just yet on disruptive technology or growth stocks. Cathie Wood keeps loading up on Tesla – but I wouldn’t touch it until it gets down into the $80 to $85 level – and I’d only be willing to do so as a speculative focus on energy trading in their massive battery operations. I don’t care about the electric vehicle play. I care about the batteries and electricity arbitrage.

Meanwhile, oil-and-gas stocks are still extremely cheap relative to the market and to the price of oil. And people are ignoring the financials... like community banks. Then, you’ve got the industrial players in the shipping industry, which have been absolutely hammered.

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Banks. Oil E&P. Niche Dry Bulk Shipping. Midstream energy.

Oh... and I’m probably going long SkyWest Airlines (SKYW). Strong F score, exceptionally low multiples (it’s trading at 3x its pre-COVID earnings and has nearly $1 billion in cash, 3.7% of U.S. market share, fair value around $44.50, a tangible book value at $47.35. It’s a natural takeover target on the back side of 2023.

The only challenge for this stock is that executives need to find more pilots.

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SKYW operates flights for pretty much everyone under United Express, American Eagle, Alaska Airlines, and Delta Connection. If I buy one, it’s SKYW, and its $20.54 cash per share.

Hurricane Ian... And the Trading Places Effect

Despite all the chatter this year about geopolitical events, higher energy prices, and increased volatility... the number one performing asset in 2022 was... Orange Juice?

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Orange juice prices rallied nearly 46% on the year, edging out the heating oil category that got juiced on the backside of the year due to diesel concerns. Driving through the back roads of Florida on several occasions since Hurricane Ian, it’s clear that the orange market took a serious hit. Moreso, we’ve seen a lot of grove owners sell their land to developers.

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The worse performer was lumber – which got crushed due to problems in the housing sector. However, contractors are still out there telling would-be home buyers or renovators that lumber prices are still elevated. I am increasingly interested in Louisiana Pacific (LPX) as a long-term recovery play in the building products segment. It’s a Warren Buffett stock.

Your Weekly Chart Party

Chart No. 1: Let’s Put Sam Bankman-Fried into Perspective

Yes, FTX lost $32 billion. But when we look at the market cap losses for Big Tech stocks, the numbers dwarf (in nominal terms) the losses in crypto. And this drawdown was even larger than all of the 2007 Subprime losses.

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As I’ll show in a moment, it’s rare when there is a second big drawdown annually. But the conditions are still quite ripe for a second-year slump that takes us back to levels we haven’t seen since before COVID.

Chart No. 2: Mega-Tech to the Teeth

Once again, there’s a direct causal relationship between stocks and the balance sheets of central banks. What goes up will come down. This is a very important lesson for the markets – and the one that all of Wall Street is betting on for when the “pivot” comes.

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There’s about $1 trillion in balance sheet reduction coming from the Fed. But they are not alone. The Swiss National Bank and the European Central Banks are pushing rates higher – and their balance sheets dwarf the relative percentage of GDP for their economies than what the Fed currently holds.

Chart No. 3: Good Riddance, 2022

This is a fascinating reminder that we are in a Financial Crisis. And we still don’t have anyone openly admitting this. There are still economists out there saying bubbles don’t

exist. There are political hacks saying that our economy is strong – yet they have an incredibly low understanding of how fiscal and monetary policy work.

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The retail investors are the ones that are going to get hurt from all this Buy the Dip rhetoric – especially from names like Jim Cramer, Cathie Wood, and more. The retail audience still lacks education – that is why the average holding time is just six months for stock, and people don’t have the long-term, private equity mindset. This is a four- to five-year market that people need to be playing. Most people lack the patience and capital for that horizon.

Chart No. 4: Yes, Things Are Slowing Down

What does it say that we dropped $5 trillion from the sky from the Fed and Congress pumped out trillions more in stimulus and spending... and we’re right back where we started two years ago.

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Some people have asked me why there has been such a controlled narrative around Twitter and efforts to control citizen journalism. I’m on the record saying this: The amount of money that has been stolen and misallocated in the last three years makes the Sochi Olympics look like a bake sale. If we ever really get our arms around how much waste, grift, and corruption has poured out of Washington, it could logically lead to a tax revolt.

Chart No. 5: Your House Is Crap

Meanwhile, after all the rampant speculation – the key source of Americans’ wealth is now moving in reverse. This is the fastest slowdown in housing prices ever. And we’re about to enter the selling season over the next two- to three months.

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How bad will this get?

Who Wore It Better?

Finally, here’s former Las Vegas Raiders quarterback Derek Carr – now unemployed and looking for a QB job – also looking like another member of the Wet Bandits.

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As I grow older and watched Home Alone over the last few weeks, I realized that Kevin McCallister is the villain. I’m keeping it short this week, and I’ll return with a longer update as I return from Chicago in six days. I wish you all a Happy New Year. Do something great this year. I have three resolutions that I’m following that I’ll discuss as the months progress.

Enjoy your week.

Garrett Baldwin

Editor, Postcards from the Florida Republic

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