We have made it.

Even as risks continued to pile up on multiple fronts, the equity market has shown resilience and determination to keep moving higher. In perspective, the S&P 500 had fallen by about 5.2% from its high seen on 2 Sept. A critical risk to the stock market has been the lowering of earnings estimates contributed by two main culprits: supply chain constraints and wage inflation that eats into the profit margin of businesses.

The Road Ahead

We have also seen how bond yields had spiked after the Fed announced plans to start tapering. As a lower level of money entered into the bond market, we saw weaker bond prices and essentially higher yield. This translated into less valuable profits for the corporation.

Nonetheless, stock markets had taken all the above in stride. They marched forward decisively. A look at S&P 500 shows a gain of 4% above its recent low. At around 4470 level, the index is above its 50-day moving average of about 4438, which is a critical technical level to confirm that it is still in the uptrend.

As more sectors participate in the rally, the breadth of the rise is showing resilience and strength. As a result, there is a higher probability of reaching the next milestone level of 4570 should the macro-environment remains conducive and less political-economy drama, often a self-inflicted crisis.

Sticky Inflation is a Concern

The third-quarter season narrative proves more insightful than ever. But, unfortunately, we have not seen the inflation data tilting to the downside. This shifts the essential economic narrative of inflation as “transitory” to a consensus that price pressure might stay longer than expected.

On this note, the September CPI data reflects a sustained rise in energy prices and firmer transportation costs such as used-car prices and airfares. However, Pika World expects most of such peak inflation worry to show relief, as the base effect starts to dwindle since the late 2020 sharp rise in prices, which may lower the percentage increases compared to the current year.

A look into the CPI confirms Pika World previous updates on housing costs which are still building steam and tends to move higher or lower for the next few quarters. Such sticker inflation often creates inertia on major stock indices.

Banks Stocks Are Gems

As big banks report their earnings this week, there is continued strength as macro indicators such as loan demands, credit card spending, and investment banking services are seeing healthy signs.

As four major banks registered about 20% growth in quarterly earnings, it had set the tone for the rally this week. Since late last year, Pika World has been focusing on this sector and has been aggressive in accumulating banks stocks for various reasons. In the initial period, we are optimistic about the bank valuations, which has potential upside. However, it has been less loved by the hedge fund, which also means it is an uncrowded opportunity for us. We have been rewarded handsomely for a sustained period and pared down some positions as we raised entry into other sectors.

Then, the Covid situation stabilised, and reflation gained engine coupled with the higher interest rate environment, which further cemented our subsequent call on the sector to hedge on the possibility of a higher interest rate.

Auto Sector in Distress

Readers of Pika World would have known our love for the sector. Our three main focuses are Tesla, General Motors and Nio, although we share updates on other auto companies such as Ford, Xpeng and Li Auto. Our play on Lucid has recently brought us a decent return as we continue to observe strong consumer spending power. Tesla has been flat for the year and has climbed remarkably well in recent weeks.

This had prompted us to initiate a call option to capture possible upswing. We are generally against opening call options as weak volatility tend to go against our positions. Therefore, we see this as a short term trade to capture a possible uptick in the stock prices.

Likewise, we had discussed in great length through multiple episodes of our updates and sharing. The critical risk lies in chips shortages, which analysts are putting a price tag of $200 billion in lost sales for 2021. If time is any indicator, we might start to see the trough forming in auto production to have ended in Q32021. Legacy car makers are more impacted than EV giant Tesla. Ford and GM are reducing the production of their key product lines, such as F-series for Ford and Equinox, GM’s Chevrolet brand.

Despite a risk on the supply end, demand for auto remains healthy as commuters shun away from public transportation and look towards spending more on a better car in the pandemic era.

Although we remain vigilant on the upcoming earnings result this week, Pika World favours Tesla as the best-in-class stock. We have also added positions in Nio as part of our broader EV play.

Rebound In Equity Market

More significant earnings beat had supported the substantial u-turn of the equity market, and a slight fall in bond yield provides relief to mainly tech-rich indices such as Nasdaq.

At Pika World, we are mindful not to become giddy on the sudden rosy outlook. Many companies have not reported their earnings, and we expect the challenges mentioned above to remain relevant through the year.

Banks that are not affected by the supply chain hiccups are the main drivers of the total earnings result in S&P 500. According to Credit Suisse, the sector had beaten profit expectations by a remarkable margin of 21%. A milder level of 5% beat was seen in other sectors.

Pika World is now looking forward to goods makers such as Honeywell (HON) and Procter & Gramble (PG) for insights into supply chain problems and labour cost inflation to corporate earnings. We remain cautious of an uptick in bond yields as long-term inflation expectations remain well above the 10-year Treasury yield, which isn’t healthy for a sustainable market bull.

As always, Pika World hopes for a moon than a blip in this uptrend market.

Till then, we will see you in our next market pulse update.