A 'Hurricane' Warning for the Markets

This tech giant just sent a warning to the markets... The economy is slowing... How much? And when does it stop?... Complicated uncertainty... Tightening has begun... Why a stronger dollar hurts profits...

The 'tip of the iceberg' is on the horizon...

Signs of trouble are becoming clearer.

Though I (Corey McLaughlin) am tempted to quote liberally from the movies Titanic and The Perfect Storm, I'll instead share the straightforward, ominous news from Stansberry NewsWire editor C. Scott Garliss...

This morning, tech giant Microsoft (MSFT) updated the earnings guidance it first gave back in early May – and the new numbers got our attention. As Scott reported, the company warned that its revenue and earnings this quarter would be lower than Wall Street analysts' expectations.

And then the company also said that for the fourth quarter of 2022, it now expects revenue to be about $1 billion lower than previously projected... and margins to be tighter.

Regular readers know Scott has been diligently tracking this trend – companies slashing forward guidance – along with the reasons for it and what it could mean for the stock market. Because it's important.

If you're a believer that stock prices reflect the present value of a company's future cash flows – a typical attitude among Wall Street analysts and money managers – you understand why share prices tend to tumble with lower expectations.

So when a mammoth company like Microsoft – a big tech bellwether with wide reach and a strong balance sheet – checks in and says it will likely make less money than it thought this year, it's worthy of discussion.

As Scott told me, Microsoft's lower guidance wasn't a "huge" cut, relatively speaking for a company valued at $2 trillion. But the company's expectations are still lower than yesterday or a few months ago...

And, more importantly, Scott said the move is just "the tip of the iceberg."

Microsoft likely won't be the only company to cut guidance soon...

We're past the heart of the current quarterly earnings-reporting season. But soon enough, the next round is on its way, starting in early July and running through August.

What happens over these next few months will likely be a catalyst for stock prices in general... and perhaps another leg down of a deeper bear market.

I'm not trying to scare anyone needlessly, just laying out the landscape as we see it... so you can prepare.

On the other hand, perhaps we get a "stop the bleeding" moment for the major U.S. indexes. If investor fears get ahead of reality, earnings reports could bring good news. But, for now, that's not the case... And we'll need to see more evidence before getting full-fledged bullish again.

Microsoft is just the latest example of lowered guidance that we've shared with you in recent weeks...

We wrote in the May 24 Digest about the social media (or as it says, "camera") company Snap (SNAP). The company cut expectations, mainly because fewer of its clients were buying advertisements to run on its Snapchat app.

On its own, that's a very real, good signal that other companies are spending less on discretionary items like ad buys – a recession-like sign. After that news, because it's not a great company to begin with, Snap's shares plummeted a remarkable 43% in one day...

A few weeks ago, retail giants Walmart (WMT) and Target (TGT) also suggested tougher times ahead, with Target CEO Brian Cornell saying the company estimates $1 billion more in fuel costs than it did at the start of the year, stemming from record-high gas prices...

Cornell also said consumer behavior was changing... to focus on more staple items instead of big-ticket discretionary purchases. Walmart executives talked about similar issues...

After their most recent earnings calls, shares of Walmart and Target fell by 25% and 17%, respectively. And these are good companies.

Microsoft shares dropped "only" 2% on today's open, then rallied to close slightly positive... This headwind aside, it's such a strong company in general and has plenty of growth potential in the years ahead.

To this point, Microsoft is also the top open position in a couple of Stansberry Research's publications. Our colleague Dr. David "Doc" Eifrig's Retirement Millionaire subscribers are sitting on a 973% gain in shares since 2010.

In other words, we're not highlighting Microsoft today because it's a troubled company. The bigger point, from a broader view, is the signal the company's updated guidance tells us about the U.S. economy in the short term.

The economy is slowing...

This shouldn't be a shocking claim to you, but perhaps it is. First-quarter U.S. gross domestic product ("GDP") contracted by 1.5%... and that was well before we started seeing any real warnings from some of the world's largest companies about lower profits.

The latest GDP projection yesterday from the Atlanta branch of the Federal Reserve – which has regularly published "live-ish" expectations for years – is for 1.3% growth in the second quarter.

But that's down from 1.9% just last week... mostly due to new data about slowing business investments. It's entirely possible these projections will go lower in the weeks ahead before the second quarter ends.

And besides... We note with great emphasis that the Atlanta Fed's projection overshot the first-quarter "real" number by 2.5%, and called for a 1% gain as recently as a day before first-quarter GDP was published.

That's a good reminder to always scrutinize your data or at least acknowledge it can be wrong.

But say you know all that already... or believe the economic predicament of America is actually worse than the numbers indicate, both for economic growth and inflation. That's not a bad bet...

If you have money in the markets and are concerned about whether asset prices will rise or fall, there are two pertinent questions: How much is the economy slowing? And when might it stop?

We can't of course answer these questions with certainty at the moment, which is kind of the point. A lot of investors are more uncertain about the future today than at any point since the bottom of the COVID-19 panic.

Back then, there was just one underlying question: When could people gather in large groups again without breathing in something completely unknown and possibly lethal?

The answer to that question dictated a lot of other things. And, of course, in the meantime, the government threw trillions in economic stimulus into the markets... to prevent financial catastrophes, they said.

In any case, the economy and stock market boomed back quick, perhaps too strongly.

This uncertainty feels more complicated today, in a financial-system sense...

Just yesterday, JPMorgan Chase (JPM) CEO Jamie Dimon said at a financial conference in New York that the firm is preparing for a financial "hurricane." He told a room full of Wall Street analysts and investors...

You know, I said there's storm clouds, but I'm going to change it... it's a hurricane...

That hurricane is right out there, down the road, coming our way.

You'd better brace yourself. JPMorgan is bracing ourselves and we're going to be very conservative with our balance sheet.

This came just a week after he presented at another conference for his own bank, saying the firm's revenue would be higher than expected, so there's some "talking out of both sides of his mouth" to consider here as well...

Still, Dimon's point yesterday about a potential major economic storm stems from two legitimate concerns, as NewsWire analyst Daniel Smoot reported...

At a conference sponsored by AllianceBernstein, Dimon emphasized that Russia's invasion of Ukraine and the global tightening of monetary policies will create an unprecedented series of challenges for the market.

Indeed, as we mentioned yesterday, the Fed this month is finally starting to shrink its nearly $9 trillion balance sheet (by $47.5 billion starting this month for the next three months) and thus reduce the amount of money supply in the financial system...

You'll hear people refer to these moves ahead as quantitative tightening, or QT, as opposed to quantitative easing, or QE, where the "easy money" flows like the drinks at an open bar.

In short, the Fed is reversing its pandemic bond-buying programs in which it bought $5 trillion of assets, mostly U.S. Treasury notes and mortgage-backed securities. (Yes, the government "creates" dollars, then lends the money to itself at an interest rate it largely decides.)

This month, it stopped reinvesting the proceeds from its bond holdings and is letting those assets run off – at a rate never seen before... Over the next three months, at the current QT rate, the central bank would trim roughly 1.6% from its balance sheet.

After that, as the Fed announced at its policy meeting last month, it wants to accelerate the process, eventually seeking to cut $95 billion per month. Of course, there was some important fine print in the announcement from the 12-member Federal Open Market Committee ("FOMC")...

The Committee is prepared to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments.

In other words, this is the plan – for now... if the economy gets the "soft-ish" landing Fed Chair Jerome Powell is hoping for. If not, the Fed could be forced into reversing policy again if we see a painful recession. That's when it will start helping the economy again, cutting rates and buying who knows what.

Today, it's worth thinking about when this might happen. That's when a new bull market run may start again – assuming record-high inflation still isn't a huge problem. So, all in all, we're with Dimon when he says this about his "hurricane" concerns...

We've never had QT like this, so you're looking at something you could be writing history books on for 50 years. [Central banks] don't have a choice because there's too much liquidity in the system. They have to remove some of the liquidity to stop the speculation, reduce home prices and stuff like that.

Outside of hitting the brakes on demand by raising interest rates, that means we're about to see a real, tangible difference in money supply and financial stimulus that will start filtering through the financial system.

If that sounds like a big deal, it is...

Dimon said yesterday that during the response to the 2008 financial crisis, central and commercial banks and trading firms were the three major buyers of U.S. Treasurys. They won't have the ability or motivation to do the same this time, Dimon said...

That's a huge change in the flow of funds around the world. I don't know what the effect of that is, but I'm prepared for, at a minimum, huge volatility.

So are we. It's wise to hold a generous allocation of cash right now. Should volatility continue and prices of stocks and other assets fall further from here, you'll preserve capital and be prepared to pounce on good buying opportunities...

And if you're going to buy, like we've written this week, take a look at high-quality and low-volatility businesses first, especially ones that are positioned to profit from today's bout of inflation.

Prices of essentials (like energy and food) are still rising at record rates, for example. Strong oil demand is still in place while supply is in question for a few reasons. Energy companies can benefit...

On the flip side, companies tied to discretionary spending could take a hit should the economy slip into a deep recession... And don't get us started on the "zombie" companies – which can't even afford to pay their debts – that could go bankrupt at a scale we've never seen.

One thing is for sure, though...

So long as the Fed is raising interest rates, that means the U.S. dollar is getting stronger – relatively speaking...

Now, I'm not talking about the dollar getting stronger enough in nominal terms to make a significant difference in what we were talking about yesterday – the decadeslong devaluation of the dollar as the fuel for inflation. We still have long-term doubts about the greenback's sticking power as the world's reserve currency for another 100 years.

But in the short term, because of the Fed and what the world's other central banks are doing, the buck is at multiyear highs – compared with other leading currencies...

Right now, the Fed is more intent on aggressively raising interest rates than the Bank of England, Bank of Japan, European Central Bank, People's Bank of China, or Reserve Bank of Australia. Japan and China are even looking to ease policy to stimulate economic growth.

In low-inflation times, a stronger dollar would mean more purchasing power and bang for your buck. But inflation is so high that costs of everything are still rising and wages aren't keeping up... so purchasing power is still being lost in real terms.

And economic growth is slowing...

Remember, keep in mind 'recency bias'...

Over the past several decades, the Fed has typically raised rates when the economy is strong. As I wrote last week...

And that usually leads to some kind of economic slowdown or a recession. And all in all, that can be healthy over the longer term. But like many things in life, it's only healthy in moderation. At the extremes, things can get nutty...

Today, higher-interest-rate policies are being put into place when we already have high inflation and economic growth was already likely to slow compared to last year.

You can look at all the statistics you want, but with at least 8% inflation in the country today... and gas prices still rising, to a $4.71 national average for a regular gallon, up more than 50% from a year ago... and most people's paychecks barely budging... the economy is not "strong."

Yet interest rates – the cost of borrowing money – are rising. It's becoming much more expensive to take out a mortgage... or do business. On the corporate level, higher costs are crimping margins... and a stronger dollar within a slowing global growth is starting to have a material impact on balance sheets, too.

Let's get back to Microsoft... and Scott's reporting today...

As Scott wrote in NewsWire today, Microsoft cited foreign exchange rates as the primary culprit for its lower guidance... and said there's potential for another $460 million in related losses this quarter because of a strong dollar.

You might think, "Oh, that has nothing to do with me or my portfolio." Au contraire, mon frère. As Scott wrote, a strengthening dollar – if it's getting stronger, quicker than other currencies – is bad for American companies that sell goods abroad. And that's a lot of them...

As our currency goes up, it means the value of other countries' currencies drop. That means it will take more, say, euros or pounds to buy an item priced in dollars.

This will play out one of two ways for a corporation selling goods abroad...

It either needs to lower prices to encourage sales or maintain prices and sell fewer products. But those scenarios mean they're either seeing profitability shrink or generating less revenue.

Almost 50% of the S&P 500 members derive revenue from outside the U.S. The change means it costs more for households and businesses in foreign countries to buy U.S.-made goods. So a rallying dollar will weigh on sales going forward.

Throw inflation into the mix – and higher costs through entire supply chains – and it compounds the problems. In short, expect more companies to do what Microsoft just did and cut their earnings forecasts in the months ahead. If this happens, as Scott says...

It means Wall Street analysts need to reduce their forward 12-month [earnings] estimates for the S&P 500. That will result in the index's price-to-earnings multiple rising. But in an environment where growth is slowing, the current 17.3 times multiple is high. Fair value is likely more between 13 times and 16 times.

So, as earnings expectations reset, the S&P 500 will experience more downside pressure until investors feel it has grown cheap enough to invest once more.

Maybe Jamie Dimon's QT hurricane never arrives and he's simply using colorful language to make headlines. That could very well be the case, but we will be on the lookout for Scott's earnings iceberg. It's not right ahead just yet, but it's lurking.

Trade Like a Pro

In this week's episode of the Stansberry Investor Hour, Dan Ferris interviews Keith Kaplan, the CEO of portfolio-tracking service TradeSmith...

In a wide-ranging conversation, Keith explains how his company's proprietary technology strives to make investing less daunting, using an easy-to-understand "stoplight system," volatility indicators, and smart trailing-stop alerts.

And, among other things, he shares stories with Dan about how much hate mail TradeSmith received when it warned subscribers early of the major market slumps in 2020 and 2022 (which, of course, came true)...

Click here to listen to this episode right now. And to catch all of our videos and podcasts from the Stansberry Research team, be sure to visit our Stansberry Investor platform anytime.

New 52-week highs (as of 6/1/22): Black Stone Minerals (BSM), CTS (CTS), ProShares Ultra Oil & Gas Fund (DIG), Enterprise Products Partners (EPD), Kinder Morgan (KMI), Suncor Energy (SU), Viper Energy Partners (VNOM), Energy Select Sector SPDR Fund (XLE), and SPDR S&P Oil & Gas Exploration & Production Fund (XOP).

In today's mailbag, feedback on yesterday's Digest about inflation – and how politicians have made it worse and can't fix it... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Corey: One of the 10 best Digests, in my opinion, that I've read from you or other contributors to the daily! In the spirit of full disclosure, I did not think I would be saying this when I began reading today. It may have been my frame of mind when I started or something else, however once you began the segment with "The government keeps printing money," I believed that this would be a thoughtful and balanced Digest and not something else. It was.

"I believe your words, graphics, use of other Stansberry analysts writings point to the real cause of our current inflationary environment. I wish that all of the individuals who read tonight's Digest would send a copy to relatives and friends. I believe it would help every reader to think and then understand why the economic environment is the way it is and who is really responsible for our current predicament.

"I have been a firm believer for many years that I, and other members of the voting public, give too little thought to how our country is managed, especially when it concerns economics. So, when you clearly pointed out about inflation and said...

Those factors (unanticipated and large shocks) made things worse, yes – but we were already headed this direction anyway. Expanding money supply, which has gone on for decades, paired with strong demand... and coupled with those supply shocks... means higher prices. It's that simple...

"... I couldn't have agreed more.

"I believe the American public gives very little thought about who we decide to lead us in the management of our country, other than Party affiliation. After tonight's reading of the Digest, I'm going to be making more of an effort to understand as many of the issues (primarily economic for me) as I can and get involved. This means involvement with friends, neighbors and even attending my Congressman's town halls.

"Thanks again for writing a thoughtful piece! It meant a lot to me and made me think about how our country is operating and ways I can participate to making it better." – Stansberry Alliance member Bill F.

Corey McLaughlin comment: Bill, thanks for the note. Those are some high compliments, of which we probably aren't worthy, but I'm glad my big point came across clear to you.

Most people don't know and many don't have the chance to understand "how we got here," how dumb things keep happening (at least as I see it)... or why exactly a gallon of milk now costs 11 times what it did roughly 100 years ago...

As much as we'd love to blame it all on Putin, that's not the case.

As Stansberry Research senior analyst Alan Gula wrote in the new special report for Stansberry's Investment Advisory subscribers that we referenced yesterday, inflation stems from increasing money supply and monetary policy of the U.S. government...

The real price of milk hasn't changed at all. It's just that the dollar has lost purchasing power amid the ever-expanding [money] supply. So it now takes more dollars to buy a gallon of milk.

It doesn't mean there won't be years when the price of milk falls. But over the long term, we should expect prices for milk and other basic products to rise.

Sometimes I feel like I'm talking into a black hole and repeating myself too much trying to explain these things – after all, the Federal Reserve isn't exactly fun happy-hour material, though maybe it should be. So please, spread these ideas as far and wide as you can.

"There is an important part of the Nixon destruction of the gold standard that hasn't been mentioned in your editorial, that is that European nations and France in particular were buying all the U.S. gold. If nothing had been done all the U.S. gold hoard would be no more." – Paid-up subscriber John R.

All the best,

Corey McLaughlin
Baltimore, Maryland
June 2, 2022