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Destocking Rebound Thesis Playing Out + Tech Earnings Caution

Published on July 20, 2023

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Dennis DeBusschere

Brian Herlihy

Kevin Brocks

Sophia Wang

SUMMARY: Our destocking reversal portfolios, which are comprised of retail and trucking names, both outperformed the S&P by over +1pp yesterday and we expect the outperformance to continue. Even with the Fed continuing to deliver below-trend growth for an extended period, companies will start to order more goods, especially given the decline in inventories, unless the economy falls into a recession. Bottom line, the conditions are still in place for the destocking reversal trade to work – the group is relatively inexpensive, inventory sentiment for retail/trucking names has improved (we measure inventory sentiment using the Amenity natural language processing tool) and outpaced equity performance, and personal consumption expenditure growth is currently tracking above 2%. Earnings continue to point to low recession odds as well.

The destocking portfolio gained yesterday following JB Hunt earnings. JB Hunt missed revenue and EPS, but management made some comments about the end of the trucking recession being near. This is the narrative that we want to capture with our portfolios. Growth is not strong, but the destocking ahead of a presumed recession still needs to be unwound. Constituents of our Destocking portfolios are at the end of this report.

TECH EARNINGS CAUTION: In our DN yesterday, we highlighted our S&P earnings beat vs miss baskets (HERE). The current sector composition of our baskets (long beat basket, short miss basket) is more Health Care and Discretionary than normal, and less Communication Services, Tech, and Financials.

Tech PEs have taken off while earnings sentiment has deteriorated. We wouldn’t short Tech; we prefer the sector on a longer-term outlook because it is Quality Growth in an economic backdrop of below-trend demand growth coupled with strong idiosyncratic themes (idio is a focus now that correlations are breaking down, more HERE). But earnings may be a near-term headwind and we continue to favor the average stock over the mega caps given the massive run in mega caps on recession/credit/consumer fears. Small caps have been outperforming. The plural of anecdote is NOT data, but TSMC is a drag on futures after missing margin estimates and guiding lower (HERE).

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MARKET VIEWS: Our destocking reversal portfolios both outperformed the S&P by over +1pp yesterday (Retail and Transports had strong days). The portfolio enjoyed a tailwind from the commentary around JB Hunt earnings. JB Hunt missed on revenue ($3.13B vs $3.28B est) and EPS ($1.81 vs $2.42 est) but beat on intermodal volume (501,681 loads vs 500,949 est). A flood of analysts gave constructive commentary about how well positioned JBN Hunt is for the trucking demand rebound, which the beat in volume may suggest is here (HERE). This is the narrative that we want to capture with our portfolios. Constituents are listed at the end of this report.

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As Gerard mentioned on Tuesday, real Personal Consumption Expenditure Growth (PCE) growth looks to be tracking in the 2-2.5% range (HERE). Bottom line, the conditions are still in place for the destocking reversal trade – the group is relatively inexpensive, inventory sentiment (we measure this using the Amenity Natural Language Processing tool) has outpaced equity performance, and economic expectations were poor – but this is a tactical trade, not a long-term theme.

Health Care (the entire sector) has the second highest earnings sentiment score. Discretionary earnings sentiment is much worse on an absolute level but has improved, which is the narrative the market has seemed to embrace as recession expectations are again pushed out. Tech’s sentiment has gotten worse q/q.

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Tech PEs have taken off while earnings sentiment has deteriorated. We wouldn’t short Tech; we prefer the sector on a longer-term outlook because the sector is Quality Growth in an economic backdrop of below-trend demand growth coupled with strong idiosyncratic themes (idio is a focus now that correlations are breaking down, more HERE). But earnings may be a near-term headwind. Anecdotes != data but TSMC is a drag on futures this morning after missing on margins and guiding lower (HERE).

Tech tends to be larger cap as well, and we continue to prefer the average stock. Large/Mega caps benefitted from expectations of a consumer slowdown and credit crunch after bank failures in 1Q. That was a very reasonable fear, but broad economic data, management sentiment, and profitability trends all suggest the economy has absorbed rate hikes without collapsing. Recession risk remains elevated but is 1) lower than it was a few quarters ago, and 2) nearby deep recession risk is MUCH lower. Expect the average stock, risk-on factors, and Cyclicals to continue to lead unless inflation remains too high (causing the Fed to re-tighten financial conditions).

Source: Bloomberg, 22V Research
Pure play destocking reversal here…

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Blended with other Deep Cyclicals to round out a better balanced basket here…

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