Imagine a Halloween many years in the future. Kids don’t dress up, but simply adopt an avatar image of themselves. They don their Meta goggles and enter an augmented reality world, with streets and houses accurately shown to mimic where they live. They encounter their school chums, also as avatars, and walk the streets with their virtual pillow bags hunting for candy. It’s nasty outside, even by Canadian standards for October 31^st, yet no one is having to layer or get wet.  Better still, the candies being tossed into the bags aren’t real and there is nothing to be worried about.

 

This is for sure a retailer’s nightmare. Given that Halloween has been generating $10-11 billion in sales in the US and north of $1 billion in Canada, mainly in candy and costumes, the metaverse sounds like a very scary movie indeed. Don’t worry though. This movie isn’t expected to come to theatres (or glasses) for several years. That doesn’t mean the word “Meta” isn’t causing some investors to shiver this weekend.

 

 

I’m referring of course to the stock once known as Facebook (now named Meta Platforms). Once upon a time, oh let’s say September of 2021, the company’s shares traded above US$380. That was ten times the value of the shares when they debuted in 2012. Years before then, I remember being on air with CTV’s Larry Stout, talking about technology start-ups. Side note here – he was an amazing journalist who we lost two years ago.  I remember tackling with the elephant question back in May 2012. Is this a stock that is going to become a dominant member of a portfolio and where do you see it going?

 

Like most other analysts at the time, I only saw potential if it could successfully monetize an advertising overlay to its social media draw. Well, we know that it was able to do that and even the setbacks of 2018 and the pandemic of 2020 would eventually become minor tarnishes. What has happened since 2021 has been a buckling of the steel of this company, rather than a tarnish. On Thursday, the stock plunged 25% to below $100 for the first time since 2016. For an augmented reality company, the latest news of disappointing revenues and then promises from CEO Mark Zuckerberg that investors just needed to be patient was a reality that no one wanted to swallow.

 

 

Shedding almost $700 billion in market cap since the start of the year is nasty, but this development wouldn’t be horrifying if it was just an isolated case. It isn’t. The technology sector has been hammered this year relative to the other major North American indices. In the second quarter, the NASDAQ 100 dropped by close to 30% as the spectre of rapidly rising bond yields created a valuation crater for growth stocks. There was no recession yet and companies seemed to be spending nicely. We had a reprieve in the summer, but then the rate hikes kept getting more aggressive and recession talk showed up more and more in the ghost stories being paraded by market watchers.

 

What is happening now, outside of Meta, is a realization that the feared recession is now knocking on the door and it’s about to hand out something less savory than treats. Amazon also came out with its latest quarterly results on Thursday and showed that sales were well below market estimates and the same for its operating income guidance.  Higher expenses were a big deal, but the highlight for most investors was how the company predicted a slowdown in sales for the holiday shopping season. A bigger factor, according to Amazon, is how the stronger US dollar is hurting the bottom line from its international sales. The stock also fell more than 20% after the initial headlines, though it recovered most of that lost ground in a very erratic Asian session.

 

 

This was a heavy week for tech company reporting and Thursday cast a shadow on what has been so far a generally positive earnings season overall. Other than industrials, most companies have delivered results that have been in line with or better than street estimates. That’s one of the reasons why the US equity market managed to put in three solid sessions until Wednesday. The S&P500 had crossed above its 50-day moving average that day, right before our monthly conference call (playback details can be found here). It didn’t get to its 100-day moving average line, unlike the Dow; but even the Dow looks as though it’s going to be capped below its 200-day line.

The good news is that barring some major shock late today or on Halloween, North American stock indices look like they will have a positive month for the first time since July. Even Europe posted strong advances in October and, ironically, the one country that showed more hope towards the end of the month – the UK – underperformed almost everyone in the developed world.

 

As I mentioned on this week’s call, as welcome as the recent bounce in stocks this past week has been, it would be naïve to think that the worst for stocks is behind us. Yes, the Bank of Canada did blink on its policy decision this week to raise rates by only half a percentage point (something it might be re-thinking as its surprise move followed remarks by some in Parliament to repent for the aggressive rate hikes since the summer). Even the European Central Bank (ECB) embedded some dovish hints into its statement Thursday, even though it delivered on a 0.75% hike in rates. The ECB council is probably glad it did, as inflation figures for the region showed acceleration in October. German inflation spiked to 11.6% - more than half a percent above forecast – while Italy’s rate jumped to 12.8%.

 

 

The one thing that central bankers are keenly aware of is that higher interest rates and talk of recession will invite suspicion of government pressure if it looks like they are becoming soft on inflation. Two officials in the US this week wrote letters to the Federal Reserve, stating that aggressive moves in rates would be detrimental to the economy. If the hope was to sway the Fed at next week’s policy meeting, the logic was failed, especially in light of the Bank of Canada situation. To not go with a 0.75% hike, which has been priced into the market for some time, would invite the same suspicion of lack of independence. Keep in mind that the US midterms are just around the corner – even more reason for the Fed to reinforce the wall between it and government. And if Jay Powell needed some additional support for a mega hike decision next week, this morning’s September PCE data showed an acceleration in this inflation metric to 5.1% from 4.9% and month-to-month spending growth of 0.6%.

 

In our opinion, if the Fed actually does follow through with another large rate hike, it will take some air out of the balloon of complacency that has crept into the market of late. The tech sector has also thrown some cold water on the notion that the economy may not be so bad. If Amazon is an accurate bellwether and holiday shopping numbers are weak across the board, then theme of a resilient consumer will fade. More companies will factor this drag into their business plans for 2023, resulting in weaker guidance and a response to market demands for remedies to lower profit margins. In other words, cutting back cash flow leakage from advertising, investment and staffing. While we may not have rose coloured augmented reality goggles to put on, our eyes have to be wide open for clues of recession evidence, since that will set the market up for a trick, rather than a treat.

 

Have a great weekend everyone

Andrew Pyle

 

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These are the personal opinions of Andrew Pyle and the Pyle Group and may not necessarily reflect those of CIBC World Markets Inc.