As investors brace for a “hawkish”-leaning Sept FOMC, notwithstanding August CPI, progress seen on inflation since June FOMC

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The September FOMC decision comes Wed at 2pm ET. Since Jackson Hole (8/26), markets have been on edge and investors have been bracing for more “hawkish” Fed commentary. This is best evidenced by the surge in yields (2Y and 10Y) and creeping higher of Fed peak expectations.

In short, investors are naturally nervous into the rate decision. But there are a few perspectives that should balance the negative bias by consensus:

• if Fed raises +75bp (or even +100bp), this puts current Fed funds within 125bp of peak rates
• with markets seeing +50 to +75bp for November, Fed will be largely done with hikes by year-end
• the last big negative FOMC “shock” was the June FOMC meeting (where Fed hastily shifted to +75bp)
• as we discuss below, the “hard” (CPI, PPI) and “soft” (surveys) show meaningful improvement into this Sept FOMC
• this is also true of market-based measures such as inflation breakevens, which are vastly better compared to June, with 2-yr and 5-yr back to 2%-ish levels
• many investors believe the clock on CPI has been reset with the negative shock of August. But we believe that given other indicators, and the possibility of Sept improving (unknown at this time), the Fed could revisit the notion July was the first “greenshoots”
• market-based measures can reset quickly, so if “hard” or “soft” data improves, this staves off the need to further accelerate tightening.

And as mentioned above, Fed Funds futures markets see the bulk of Fed tightening in by year end. Of course, this is path dependent. But as we have noted in multiple prior comments, the leading indicators point to inflationary pressures cooling.

And the message from inflation fixed income markets is encouraging. Look at the comparative levels of inflation breakevens:

• in June, the 2Y breakevens were 4.11%, and now 2.35%
• the 5Y-5Y were anchored and remain anchored

While August CPI negative surprise, other soft data better versus June

The Fed has placed signifiance on the CPI, so there is no sense in diminishing its importance. But we believe the August CPI stands in contrast to the vast other incoming data points:

• as shown below
• Energy has dramatically improved since June, and as many economists correctly note, higher Energy is the root of many prior inflation episodes
• U Mich survey shows meaningful improvements in both 1-yr and 5-yr
• importantly, the 1-yr inflation expectations are now well below any reading seen during the 1970s-1980s
• even PMIs “prices paid” show vast improvements and are further supported by the drops in PPI

U Mich 1-yr inflation expectations break below levels prevalent throughout 1970s-80s

The drop in consumer inflation expectations could ultimately have an important effect on monetary policy. After all, if consumers see declining inflation risks, this makes the Fed’s job easier. And more importantly, it mitigates the risk of an inflation-price spiral.

• the U Mich consumer 1-yr median inflation has fallen to 4.6% from 5.3% in June
• this is a meaningful improvement and a break from the surging trend seen in the past year
• and as highlighted below, is a break below the high levels seen throughout the 1970s-80s
• in other words, this helps reinforce the break from the 1970s-80s analog

CPI Rents could soon be improving, even as this remains sticky

Lastly, the updated rent data from ApartmentList.com and Zillow.com are showing somewhat promising trends:

• month over month increases are slowing
• and seasonal trends (right) show this hopefully further improves into YE
• a model by JPMorgan Economists show that OER CPI/shelter CPI could be peaking now

And the encouraging aspect is that JPMorgan economists see the trends in zillow.com data as pointing to a possible peak in shelter CPI in 2022:

• their model is based on predicted shelter CPI using zillow data
• this implies CPI shelter should cool slightly into YE
• August CPI shelter +0.7% m/m
• Dec ’22 CPI shelter forecast +0.59% m/m
• June ’23 CPI shelter forecast +0.42% m/m
• Dec ’23 CPI shelter forecast +0.30% m/m
• this is roughly 33% of the CPI basket and shows a pretty rapid deceleration

STRATEGY: 2H rally view intact

Given the list of market worries above, the natural question is how is there a positive thesis on equities into 2H2022? Here is our take:

• our continuing analysis shows leading indicators point to disinflationary/deflation
• US corporates remain impressively resilient, enduring the pandemic global shutdown with cost discipline
• and US corporates are weathering the inflation surge impressively as well
• the US economy has managed to absorb rapid Fed rate hikes so far
• and US economic relative positioning far stronger in 2022
• US net beneficiary of higher energy prices, absolute and relative (US exports oil)
• US is on-shoring assets = future competitive advantage
• US has labor issues, but this will be solved by either automation or rise in workforce participation
• investor sentiment is rock bottom and worse than GFC by some metrics
• fixed income markets show far less inflation in swaps, etc
• and while many believe “bonds are getting it wrong” including Fed officials
• the drop in energy and housing and other indicators are supportive of this lower inflation outlook
• hence, Fed could do far less tightening as the market is doing Fed’s work

Bottom line. We see 2H rally thesis intact.

STRATEGY: 2022 Bear market was 164 days, or 25% duration of prior bull

Our data science team put together the comparative duration of bull markets and bear markets, and the corresponding ratio:

• since 1942, there have been 14 such cycles
• median ratio of bear vs bull is 31%, meaning a bear market is roughly 1/3 duration
• since 1982, this ratio is only 15%

• in 2022, the preceding bull market was 651 days
• the current bear market was 164 (using 6/16)
• or 25% ratio

As seen below, this ratio is solidly within the ranges seen since 1982.

• many investors think “more time” is needed for this bear market
• but given the shortness of the preceding bull market 651 days versus 1,309 median
• the corresponding bear market should also be shorter

BUY THE DIP REGIME: Stocks already saw fundamental capitulation

And we want to revisit the chart below, which looks at the internals of the S&P 500 — the % stocks >20% off their highs, aka % stocks in a bear market.

• this figure surged to 73% on 6/17
• this was only exceeded 3 times in the past 30 years
• each of the 3 prior instances was the market bottom
• we think this is the 4th instance

BUY THE DIP: forward returns strong

And stocks have the best forward returns when this figure exceeds 54% as shown below:

• in 3M, 6M and 12M
• the best decile for returns
• is when this figure is oversold >54%
• hence, buy the dip regime is in force

33 GRANNY SHOTS: Updated list is below

The revised 33 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 5 of 6 portfolios
• $GOOGL $MSFT in 4 of 6 portfolios
• $AMZN $META in at least 2
• This reinforces our favorable view of FANG in 2H2022

33 Granny Shot Ideas:

Consumer Discretionary: $AMZN, $AZO, $GPC, $GRMN, $TSLA

Information Technology: $AAPL, $AMD, $AVGO, $CSCO, $KLAC, $MSFT, $NVDA, $PYPL, $QCOM

Communication Services: $GOOGL, $META

Energy: $CVX, $DVN, $XOM

Financials: $ALL, $AXP

Real Estate: $AMT, $CCI, $EXR

Health Care: $ABT, $BIIB, $ISRG, $MRNA, $REGN

Consumer Staples: $BF/B, $MNST, $PG, $PM

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33 Granny Shot Ideas: $AAPL, $GOOGL, $MSFT, $ALL, $BF/B, $CSCO, $NVDA, $PG, $PM, $ABT, $AMD, $AMT, $AMZN, $AVGO, $AXP, $AZO, $BIIB, $CCI, $CVX, $DVN, $EXR, $GPC, $GRMN, $ISRG, $KLAC, $META, $MNST, $MRNA, $PYPL, $QCOM, $REGN, $TSLA, $XOM

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