July 20, 2023 | Peel #504

Silver banana goes to...

In this issue of the Peel:

• NASDAQ is planning a special rebalance in order to address the problem of large-cap stocks having an outsized composition within the index.
• Goldman Sachs’ profit took a tumble last quarter on real estate markdowns and an investment banking slump.
• Euro-area inflation reports painted a mixed picture, leaving investors left wondering what the ECB’s next move will be.

Market Snapshot

Happy Thursday, apes.

It’s beginning to look a lot like… Groundhog day! Stocks rose again for the third time in a row on pretty much the same headlines as always, which include some form of “Tech companies,” “AI stocks,” and “bank earnings.”

Despite a weak earnings report from Goldman Sachs, gains in Apple, Carvana, and other AI-related stocks did their part to propel equities. In the bond market, Treasuries rallied on the back of a report showing easing inflation in the EU and the UK.

Let’s get into it.

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Banana Bits

• Broadcom received conditional approval from the UK Government for its purchase of VMware
• Wesleyan University ends legacy admissions after a recent controversial Supreme Court decision
• The MTA is set to vote today on NYC subway price increases for the first time in 4 years
• Meet the Federal Reserve’s newest economic intervention mechanism, Taylor Swift

Macro Monkey Says

The Ball Is in the Royal Court

It’s not often that you get the answers to the test before the test. That is practically what European Central Bank Governing Council President Joachim Nagel provided investors when he said it is “almost certain” that interest rates will be raised again in Europe next week.

“Virtually everyone is anticipating a 0.25 percentage-point increase,” was the exact quote. Sounds pretty clear to me.

What happens after next week is the more interesting piece of the puzzle in light of the new Euro-area inflation mixtape that just dropped. My review: It’s a solid 6/10, doesn’t have a clear goal of what it’s trying to portray, and leaves listeners feeling a bit uneasy.

"The headline rate of inflation slowed to 5.5% versus 6.1% last month, while core inflation ... actually rose slightly ..."

In other words, the report is a little hard to make heads or tails of. On the one hand, it confirmed that inflation is still alive and well. On the other hand, it showed that inflation is at least easing in key areas.

The headline rate of inflation slowed to 5.5% versus 6.1% last month, while core inflation (which excludes clothing and travel-related expenses) actually rose slightly to 5.5% from last month’s 5.4% reading. Not great.

European investors were much more forgiving as the Pound slid versus the Dollar and the Euro, a sign that people see the light at the end of the ECB tunnel. Ok, fine, I’ll switch gears and put my optimistic spin on it to explain why.

To some folks out there, the report was more positive than negative, showing that prices are on a downward path. They would say that the core inflation increase has to do with a lower base comparison in public transportation.

Last year, a public transport ticket was introduced in Germany from June to August for €9.00 per month. Additionally, substantial statistical distortions linked to changes in the weights used to compute the HICP Index are being cited for adding 0.4% to inflation.

"Europe has struggled to bring inflation down. Part of this has to do with gas prices."

Compared to the US economy, Europe has struggled to bring inflation down. Part of this has to do with gas prices. Oil & Gas declined last month in both the US and Europe, but with oil being priced in dollars and the dollar gaining strength last month, this means that oil was more expensive for other currencies.

The US also increased its domestic energy supply, making gas and other items that depend on energy much cheaper. Europe has not had the luxury of cheap energy prices, which has prevented inflation from abating as quickly as ours has domestically.

Still, Dutch Central Bank Governor Klaas Knot commented that any rate hikes beyond July are “by no means a necessity.” He is just one of a large crowd of economists and central bank leaders who expect core inflation to start declining decisively in September, pointing to an ECB rate pause.

What's Ripe

Colombier Acquisition Corp (CLBR) ↑ 55.62% ↑

• This is a blast from the past. We haven’t seen a SPAC making headlines in a while. Colombier Acquisition shares spiked on tweets from Donald Trump Jr. voicing his support for the company’s upcoming deal with PublicSq.
• If SPAC and Donald Trump Jr. look strange in the same sentence, then let’s take a step back. PublicSq is the up-and-coming “anti-woke” media company signing deals with former TV hosts like Tucker Carlson. Colombier SPAC is looking to acquire the brand.
• Colombier has captured the attention of high-level politicians and high school students day-trading on StockTwits, which is an even stranger group to put in the same sentence.
• News is heating up as the company’s shareholders held a vote on the deal. Combined with the recent signing of Carlson, if PublicSq successfully pulls off an IPO, this would be huge for the brand as it is a newcomer in the political sphere.

Carvana (CVNA) ↑ 40.20% ↑

• Carvana added to its 1,100% gain this year. That has to be a record, right? I can’t do all the work; you can look that up on your own time. The online used-car dealer announced a deal to restructure its massive debt pile.
• It’s a bit frightening how ferociously investors move markets in either direction based on good or bad news. Every day in the market feels like going 12 rounds with Mayweather. Carvana, which was the most hated company with a stock price below $5 in December, is now up over 1,000% since then. Fundamentals? What are those again?
• The restructured debt deal, along with an agreement to sell $1bn worth of stock, adds a much-needed injection of cash for a company that was on the brink of bankruptcy not long ago. Total outstanding debt will be around $1.2 billion, but the deal eliminates 83% of Carvana’s total debt until 2027.

What's Rotten

Toast (TOST) ↓ 15.71% ↓

• Toast hit the cha cha slide and reversed an initial plan to add a $0.99 processing fee to the new version of its digital ordering suite. Originally, it was thought that the additional fee would add an extra 7-10% of gross profit increases. Now the company says they made the wrong decision.
• Management reassured investors that they “do not expect the decision to have any material impact to its previously announced guidance for 2Q.” *Checks stock price* Yea, it doesn’t seem like the market took that comment seriously.
• Still, one has to applaud the company for not enacting price increases. You would have to imagine that management believes they can make more money without it, hence the decision to keep prices where they are.

Omnicom Group (OMC) ↓ 10.36% ↓

• The advertising form known as Omnicom slumped today. Earnings were positive, but Q2 revenue came up short of expectations. In this environment, that sounds like a pretty darn good report to me, but the market felt otherwise.
• Omnicom’s EPS came in ahead of expectations at $1.81 vs. $1.68 YoY. CEO John Wren described 3% organic growth guidance for the full year and 5% as an optimistic growth rate.
• Developments on the AI front will have a profound impact on the industry, and Omnicom sees massive opportunities to deliver better work to its clients via AI in the future.

Thought Banana

Special Times Call For Special (Re)measures

We’ve discussed before how basically all of the YTD returns for both the S&P and Nasdaq have been driven by 7 large-cap stocks. This has led to a dangerous concentration of these stocks’ weightings in those indices.

In this scenario, the market is like your friend who looks healthy and beautiful on the outside while their internal organs are gasping and/or pleading for a glass of water.

On the surface, a 37% gain for the NASDAQ and 18% for the S&P seems amazing, and in many ways, it is. Investigating any further into the composition of those indices tells a much darker story. So, if you are one that prefers to keep the rose-colored lenses on, you can stop reading here. You have been warned.

Companies like Apple, Amazon, Google, and the like have all been dominant household names for quite some time. This means that more people purchase the stock, and in turn, it means that the market cap of those companies continues to increase. As that happens, these stocks comprise a larger percentage of the index they are part of.

"This means that more people purchase the stock, and in turn, it means that the market cap of those companies continues to increase."

Let’s get into the numbers. The top 10 stocks in the S&P make up 32% of the index’s total weighting, and the top 10 tech stocks make up a whopping 52% of the Nasdaq index. This is great when those companies are doing well and bringing up the market with them, but this presents two problems.

1. It is a misleading gauge of the overall stock market. Indices and ETFs are meant to give investors exposure to a diverse spread of stocks and sectors. For example, the S&P 500 should, in theory, give you exposure to 500 of America’s best companies.
   Instead, investors are basically getting exposure to a few large stocks. If 490 of those companies are performing poorly, but the top 10 are doing well, the S&P 500 will rise, giving the impression that the market is healthy when in reality, it is not.
2. The past 10 years have been great for tech stocks, which have risen equities tremendously, so it hasn’t been much of an issue. But if those names were to reverse, the drawdown on the entire market would be massive.

"The Nasdaq is taking a stand ..."

Ok, the scary part is over. Someone please tell the readers that dropped off they can come back now.

The Nasdaq is taking a stand and proposing a one-time “special” rebalance in order to address the issue. This rebalance will take place on July 24th and will adjust the weights of constituents within the index and ensure that large companies aren’t taking up as much space. This also means that some of the smaller companies in different sectors will be weighted more heavily.

If you are a casual investor in passive index funds like SPY or QQQ, this means you are getting a more diversified portfolio, which is a good thing. Spreading your investments across different sectors and companies provides protection from downside scenarios like geopolitics, economic conditions, or changing sentiment.

Banana Brain Teaser

Yesterday — Two US coins total 35 cents in value. One of them is not a dime. What are the two coins?

Because one of the coins is not a dime, the other coin could be. Assuming that one coin is a dime, which has a value of 10 cents, the other coin must be a quarter, which has a value of 25 cents, to total 35 cents. Therefore, the two coins are a quarter and a dime.

Today — My twin lives at the reverse of my house number. The difference between our house numbers ends in two. What is the lowest possible number for my house?

Shoot us your guesses at [email protected] with the subject line “Banana Brain Teaser” or simply click here to reply!

Wise Investor Says

“I don’t look to jump over 7-foot bars: I look around for 1-foot bars I can jump over.” — Warren Buffett

Happy Investing,

Patrick & The Daily Peel Team

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