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EATING TURKEY IS CONSENSUS: Belief in a “hard landing” as ubiquitous
The conviction that the US is hurtling towards/or already in a recession is ubiquitous. Many can cite a litany of statistics such as:
- inverted curve,
- Fed hikes so fast and so high, it is going to break something,
- plunge in PMIs,
- collapse in CEO sentiment,
- commodity price movements
- inflation will take “years to control”
- earnings estimates will fall
- S&P 500 is below the 200D moving average and every rally has failed there
Belief in this coming “hard landing” is as widely held as eating turkey on Thanksgiving day.
- 88% of Americans eat turkey on Thanksgiving
- Is there any other day where something is this ubiquitous?
- based on our conversations, this 88% is lower than the % who expect a recession in 2023
Markets are not fighting the Fed if inflation is cooling…
The minority view, which is also mine, is that much of the US inflationary pressure in 2022 has transitory components:
- supply chain,
- bullwhip effect,
- one-offs like healthcare insurance
- even services like travel had “revenge spend” (not last forever)
Thus, the Fed did not need to go full Volck-an to fight inflation. And as JPMorgan Economists note (shared by @cquintanilla) the October CPI showed that a “decent amount of the inflation…over past year will be to be temporary or transitory.”
Markets have priced in “Fed hawkish” mode as Fed has to be taken at face value
If this is indeed the case, then markets are not “fighting the Fed” if inflation is cooling:
- markets take Fed at “face value” as Fed is in full inflation fighting mode
- thus, consensus implied prices on forward Fed hikes and forward inflation rates are reflective of Fed guidance
- in other words, the consensus view reflects the Fed and conversely, the Fed view is consensus
- thus, inflation trajectory softens, so will the Fed view and so will markets
- in short, equities can rise sharply if the Fed view on “sticky inflation” proves too hawkish
- that is our belief
CEO CONFIDENCE: Fed credibility is so high, even CEOs have reacted to Fed
The Conference Board conducts a quarterly survey of CEOs and collects various data on their views but the composite figure is shown below as CEO confidence.
- this survey has been conducted for nearly 50 years, so it is useful
- the current figure is 32 as of October
- as show below, it is basically the lowest reading ever
Historic collapse of CEO confidence
The speed of the collapse of CEO confidence is historic. The peak to trough decline is 18 months:
- the decline of 18 mos is twice as fast as next fastest collapse (Mar 2017 to Sept 2019)
- both 2022 and 2019 cycles were due to Fed tightening, not business cycle dynamics
- see the issue?
- CEO confidence has collapsed due to Fed cycle, not business cycle
FINANCIAL CONDITIONS: Pretty much drives CEO confidence
Since 1983, financial conditions (FCI) have played a large role in CEO confidence.
- as FCI (using GS FCI) tightens 12M
- CEO confidence wanes
- so CEO confidence is not necessarily a good predictor of what will happen to EPS
- as many are arguing
Usually EPS would already have to be tanking to make CEOs this negative… more reason Fed is driving collapse
In fact, look at this comparative scatter of CEO confidence and EPS YoY growth.
- when CEOs this negative
- EPS YoY is usually solidly collapsing -10% YoY (see shaded)
- But latest YoY EPS growth is +6%
DRIVING CONSENSUS: Fed is driving both market and CEO consensus views
The point I am making is the Fed and its guidance are driving market views (inflation breakevens, fed futures) and driving CEO confidence (see above).
- if inflation softens, as we expect
- we believe markets will adjust abruptly
- if inflation softens faster than Fed expects (which is also what consensus expects), this could shape up to be a 1982 moment
- in 1982, S&P 500 in a mere 4 months, recovered the entire 27 month bear market.
STRATEGY: Given the above, we see possibility of S&P 500 reaching 4,400-4,500 by YE
We think this rally has more support compared to the June “false pivot” rally to 4,325 (see below).
- thus, we see S&P 500 rallying above that level towards 4,400-4,500
PUT-CALL: Curiously surged yesterday
The tweet by @hmeisler caught my eye.
- S&P 500 was +1% yesterday
- but CBOE Equity put-call ratio jumped to 1.13
As shown below, a surge in CBOE Put-call ratio generally happens on a down day. That is logical:
- markets trade down
- investors seek to hedge, buy puts
- investors bet on continuing trend, buy puts
CONTRARIAN SIGNAL: Since 1997, only 3 precedent instances of this…
One of our data scientists, Matt Cerminaro, noted that this is indeed a rare occurence:
- since 1997
- only 3 instances of CBOE Equity Put-call >1.0 and S&P 500 rising +1% on that date
- as shown below, the forward returns for equities is very good
STRATEGY: Keep in mind the seasonals
Keep in mind the positive seasonals in YE. We highlight market returns (since 1987) based upon sentiment.
- when sentiment is the most negative (see red line, ex-2008)
- stocks perform strongly into YE
- this is roughly 7-10% upside from here
Please don’t ignore the 6 key signals from last week
Most of 2022 has been a cascade of ever more troubling developments, from surging inflation, Russia-Ukraine war, Fed going full Volcker, China issues and multiple seismic crypto events (terra luna, 3 Arrows, Voyager Digital, and now FTX). And this has pushed interest rates higher, panicked policymakers and punished equities. Still, equities found some sort of footing on 10/13 (day of Sept CPI) and since risen 15%.
Last week was a “game changer” in our view, principally due to the far softer and repeatable Oct CPI but there were 6 signals generated last week. Each of these 6 are why we see a far different path forward for markets:
- Foremost is the positive Oct soft CPI (and repeatable) which showed a favorable break in 3 key inflationary areas: shelter/OER, medical care and goods (apparel and used cars). We expect this to be sufficient for Fed to slow pace of hikes, and possibly December 2022 may be the last hike.
- Second, bond volatility is collapsing ($VXTLT or $MOVE) and this is a point made repeatedly by one of macro clients (HA in NYC, who works at a major pod of macro HF). Similarly, Tony Pasquariello of Goldman Sachs notes bond volatility “is one asset that every other asset is priced off.” For perspective, TLT Vol ($VXTLT) lows has marked every equity market high in 2022. The 8/12 low of 17 marked S&P 500 highs of 4,300.
- VXTLT has plunged from 33 to 21 in less than 15 sessions and we expect to fall to 15 or so. This collapse in volatility, in our view, would support S&P 500 surging to 4,400-4,500 before YE.
- Third, US yields saw a massive decline ranking in the bottom 1% largest downside moves in the past 50-years. Analysis by our data scientist, Matt Cerminaro, shows yield declines of this magnitude portend further declines in rates 6M and 12M forward. In other words, chances are rising the highs for the 2Y and 10Y yield are in further supportive of P/E multiple expansion.
- Fourth, USD ($DXY) posted one its largest ever declines (6D) falling -5.8%, ranking it the 8th largest ever decline since 1970. As our data science team shows, USD historically lower 6M and 12M later. Increasingly looks like the top is in for USD as well. Several FX strategists are making similar comments including Deutsche Bank’s George Saravelos.
- Fifth, there is economic signal in the fact that Republicans fared poorly in 2022 midterm elections. While preliminary, it looks like Democrats will hold a majority in the Senate and Republicans have only a slim margin in the House. While many politicos call this an indictment of Trump, we think the bigger message is the economy is simply not bad enough for voters to kick out the Democrats. Inflation arguably is not bad enough that voters are blaming incumbents. Think about that. If inflation is “as bad as 1980s” I would have thought midterms would have been an incumbent massacre.
- Sixth, crypto had one of the tsunami of financial collapses ever (largest in dollar terms), with liquidations (to zero) of >300,000 accounts with leverage and the stranding of $10b or more in assets in FTX along with further contagion effects. Only Mt Gox hack was worse. Yet, the S&P 500 managed to post strong gains in the final two days of last week. This shows that investors are becoming more discerning, rather than “hit the sell button” on any bad news.
BOTTOM LINE: Case for a sustainable rally in equities is the strongest it has been in 2022
In our view, the case for owning equities is the strongest now than it has been in all of 2022. The reasons are cited above. But consider this additional perspective:
- Skeptics will say “growth is the problem now” and point to downside in EPS. But as we have written (see below), S&P 500 has historically bottomed 11-12 months before EPS troughs. So EPS is lagging.
- In 2020 and 2009, S&P 500 bottomed 12M and 10M before EPS bottomed. Since 1900, 13 of 16 major equity lows saw S&P 500 bottom before EPS. See table below.
- From 1982 to 1990, S&P 500 EPS only grew a cumulative 19% (or 2% per annum) but S&P 500 3X. Collapse in bond volatility (risk of higher rates) matters far more in our view
- If inflation is indeed slowing to a 3.5% annualized pace (0.2% to 0.3% per month, as we expect), this shows inflation is far less sticky than inflationistas have argued.
- While we have maintained that view “inflation not as sticky” (given the constellation of leading indicators), it is only now that we are seeing this in the “hard” data (CPI)
- Lastly, recency bias is keeping investors bearish. We have many clients telling us October CPI did “not change a thing. Inflation still too high and Fed will keep raising until something breaks”
- We still see a rally into YE
Rally should exceed the “June false dawn pivot”
As far as market implications, we think the case for a strong rally into YE has been strengthened:
- Foremost, Fed no longer has its “back to the wall” on inflation as October CPI beat looks repeatable and therefore the case for a pause after December is stronger. This counters the hawkish rhetoric of Powell post-FOMC but he did not have October CPI in hand.
- For most of 2022, Fed has not been able to point to measurable progress on containing inflation but a significant constellation of leading indicators showed deflation/soft inflation was in the pipeline. October CPI is the first month the “hard” data syncs with the “soft” data.
- Softening inflationary pressures strengthen the case for a “soft landing,” counter to the consensus narrative that Fed is spiraling economy to a hard landing. Core inflation running at 3.5% annualized (above) will not require Fed to bang out +75bp and arguably 4.5% Fed funds would be very tight.
- A Fed shifting from “higher in a hurry” to “predictable but possibly longer” is far better for risk assets. Fed has acknowledged serious and unknown lags in monetary policy and with inflation improving, Fed can gain some measure of patience.
- While some bears say the Fed doesn’t want equities to go up, this is an oversimplification. Fed just was in a hurry to slow things down in 2022. Stocks are far more complex than bonds which are arguably two variable assets (inflation and future Fed funds).
- Stocks are acting like “beach balls under water” because P/E averages 19X when 10Y between 3.5% to 5.5% — true since 1871. Thus, those arguing P/E should be 15X or less are just plain ignoring history.
- The “false dawn June pivot” rally lasted 23 trading days and saw S&P 500 rise +16%
- We believe this “Fed pause” rally should last closer to 50 days and push S&P 500 +25% higher. Thus, we think S&P 500 should surpass the 200D average of 4,100 and given possibility of another weak Dec CPI could see a move well beyond that. Why wouldn’t 4,400-4,500-plus be a possibility?
- Recall, in 1982, following the final low in August 1982, the S&P 500 reached a new all-time high within 4 months, erasing entire 27-month bear market. That was a vertical rally. Vertical.
37 GRANNY SHOTS: Updated list is below
The revised 37 Granny shots are shown below. The list is sorted by the most attractive (most frequently cited) to least. To be a “Granny shot” the stock needs to appear in at least two portfolios:
- $AAPL in 4 of 6 portfolios
- $GOOGL $MSFT in 3 of 6 portfolios
- $AMZN $META in at least 2
- This reinforces our favorable view of FANG in 2H2022
37 Granny Shot Ideas:
Communication Services: $GOOGL, $META
Consumer Discretionary: $AMZN, $AZO, $GPC, $GRMN, $ORLY, $TSLA
Consumer Staples: $BF/B, $MNST, $PG, $PM
Energy: $CVX, $DVN, $EOG, $PSX, $XOM
Financials: $ALL, $AXP
Health Care: $AMGN, $HUM, $UNH
Information Technology: $AAPL, $AMD, $AVGO, $CSCO, $KLAC, $MSFT, $NVDA, $PYPL, $QCOM
Materials: $CF, $FCX, $LIN
Real Estate: $AMT, $CCI, $EXR