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Do you want to listen to economists or to markets? Who has a better track record?
The stubborn rise in equities in 2023, in the face of skeptics citing high inflation, Fed killer, recession risks and poor EPS prospects, highlights the battle that is 2023. Do you want to listen to economists or to markets?
For much of 2022, the equity world has taken the Fed and economist arguments at face value — inflation is persistent and risks to flaring higher are high, so the Fed will keep pushing on stock prices, until something breaks. This is gospel for many and we hear this mirrored to us countless times in the past six months.
But why are the bond market and now stock prices speaking a different tune. In fact, if you happened to watch CNBC Squawk Box this morning, there was a heated debate on the CPI report and Rick Santelli, CNBC guy, pretty much summed it up:
- when he said “who has a better track record? economists or markets?”
I will place my bets with markets. As we have written about consistently since last Fall, the stock market has been marching to a “bull playbook” since October 12, 2022 and despite those deeming this current rise as a mere bear market rally:
- Equities are up >20% from October 2022 lows.
- YTD by day 26, S&P 500 >5%, and since 1950, 16 of 17 times lead to further gains by YE. Astoundingly, 71% of those years saw >20% gain vs 14% probability in other years
- So, S&P 500 4,800 should arguably be the base case
- There are strong market internals as well, evidence by 3 major momentum breakouts on 1/12/2023, something that has not ever happened in any trading day since 1970.
- Yet, most fundamental investors see only reasons to fade this rise, although in our view, the move in equities is rational if inflation is set to fade faster than expected in 2023. Given housing is >33% of Core CPI and that is set to rollover, we think this is one of the key factors for equity resilience.
- CPI was reported Tuesday, and while it was in-line, the re-weightings in CPI lead to housing becoming 43% of Core CPI (up 400bp vs 2022) and now the highest weighting in the last 25 years as shown below.
- Guess what? This means when housing rolls over, CPI Core is set to get dragged down with it, seeing it is now 43% of the index.
CPI: A little “hot” for Jan, but the re-weightings is setting up for large fall in mid-2023
The revisions to CPI weightings contributed to the slightly hotter Jan CPI which came at 0.4% core vs Street +0.4%.
- as highlighted by Jeffries, the bigger weight increase is in shelter.
Shelter is now 43% of Core CPI, the highest ever weighting as shown below, meaning shelter and OER have never been more important to core CPI.
CORE CPI: Now basically housing and cars…‘
With this re-weighting, core CPI is now 59% comprised of housing and autos as shown below.
- this is huge
- but it is also telling us these two components will drive CPI going forward
- Autos is set to continue to weaken as supply chains ease = falling inflation
- housing is set to being matching the declines seen in rents and market prices = falling inflation
- this is a very positive set up for inflation into mid-2023
And more conceptually, look at both tails of inflation:
- Energy prices are stabilizing, not surging = inflation cooling
- Housing is cooling = not in CPI yet, but will show up
In fact, the best evidence is seen by the dual surveys of consumer inflation expectations.
- NY Fed Survey of Consumers shows 3-yr inflation fell to 2.7%, the lowest since mid-2020, an utter collpase
- U Mich shows long-term inflation still anchored at 2.9%
- Is there really an inflation issue if consumers see inflation at lower levels?
RECESSION RISK: CEOs and Institutional Investors see declining risk of recession
When the Fed began its “higher in a hurry” in 2022, CEOs and investors put the economy on recession watch.
- But as the analysis by Goldman Sachs shows, companies mentioning recession have plunged from >40% on earnings calls to 12%.
- This is inline with 2016 levels and generally around levels that show far less economic stress.
- While some might view this negatively as some see it as a need for Fed to do more hikes to push conditions towards recession, think about what this means for corporates and what they did last year.
- As talk of recession mounted last year, businesses also hunkered down and this meant their business plans slowed, etc. This is arguably supportive of EPS in 2023. After all, if companies were cautious with expenses in 2022 (recession talk), then there is operating leverage in 2023.
In fact, investors are also reducing their recession calls. As shown below, the net % of investors seeing a recession is on the wane.
- after spiking into November 2022, this figure has plunged
- this is similar to April 2020 and March 2009, when investor expectations for a recession peaked
- Isn’t this also an argument that a new bull market has started? Like the bad news is priced in?
RETAIL: Rage sold in 2022 and now sitting on $1.8T cash pile
Last year in 2022, retail investors were liquidating stocks at such a furious pace that cash balances sit at an all-time high of $1.75T, surpassing the $1.6T peak at the pandemic equity market lows.
- retail investors, in our view, will be the incremental buyers in 2023
- they rage sold in 2022, raising a cash pile exceeding the pandemic panic selling
- CEOs and institutional investors are reducing their recession calls.
One of the best ways to see retail sentiment is to look at the AAII survey % net bulls. This is showing how retail bearishness is at levels perhaps never seen in the history of the survey:
- Net % bulls never registered a positive reading in 2022 and enduring the longest and most negative streak in 2022.
- Take a look below, the 52-week average was -22% through 1/12/2023.
- 1/12/2023 is notable as this was also the date of the trifecta of breakaway momentum registered.
- And as shown below, the inflection upwards is notable.
- This turned up in May 2009 and confirmed the equity lows.
- This, in our view, is another sign that equity markets made their lows on Oct 12, 2022.
INSTITUTIONAL: And in a contrarian sign, 2/3 call this a bear market rally
Investors are too reliant on economists suggesting the US is on a path to a recession, hence, this is only a bear market rally. The latest BofA survey shows 2/3 see this as a bear market rally.
- combined with the rage selling of retail, argues why stocks have upside
- there is a huge wall of worry ahead and a lot of liquidity and skepticism
TACTICAL: Feb shaping up to be tough month
In the shorter term, we think January borrowed from February. As shown below, in those years when markets are up >5% thru day 25 (like 2023), into month-end:
- win-ratio into month-end is only 53% and is lower than 67% for other months
- so, Jan strength borrowed from February
- but it doesn’t change the positive outlook into YE
MARKET STRUCTURE: Vast improvement in market structure – 5 SIGNALS now
Lastly, the S&P 500 has seen vast improvements in market structure. This is something that Mark Newton, our Head of Technical Strategy at Fundstrat, has been commenting upon. Take a look:
- on 1/9/2023, the “rule of 1st 5 days >1.4%” triggered
- on 1/12/2023, the trifecta of market breadth triggered, first time EVER since 1950 (see past reports)
- on 1/23/2023, the 3rd day S&P 500 close >200D, first time since Jan 2022
- on 2/2/2023, S&P 500 “golden cross” where 50D > 200D, first time since March 2022
- on 2/7/2023, S&P 500 closed above 50% retracement of entire decline for 2nd day
The list is growing to validate that internal market structure of S&P 500 is vastly improving.
STRATEGY: Technology is primary beneficiary of Fed “course correction”
The best way to play easing financial conditions, in our view, is owning Technology and even small-caps. As the charts below highlight, both $QQQ and $IWM are breaking out decisively
- IWM is more evident as the breakout was 1/11
- QQQ breaking out on a relative basis and just crossed above the 200D
And Technology remains a group where there are many down and out names.
- ~20% of Technology stocks in the broad market index Russell 3000 are >75% off their highs
- That means 1 in 5 technology stocks has been absolutely obliterated
And as shown below, there is a greater bludgeoning in Healthcare and Comm Services (which is essentially TMT).
Similarly, short interest has been rising in Technology. So this rally YTD has been met with investor skepticism and they are increasing their short selling of Technology. To me, this is fuel for further upside.
Technology largest beneficiary of easing FCIs and less correlated to PPI
The two big macro changes to impact 2023, in our view, are:
- easing of financial conditions, of FCIs
- easing of PPI, or easing of cost pressures for producers
- some sectors are negatively impacted by falling PPIs as this spells margin pressure
As shown below, Technology is arguably the greatest beneficiary of each:
- Technology at 88% has the highest correlation to easing FCIs
- and has less exposure to PPIs falling as margin correlation is only 28%
Moreover, Technology technicals seem to be improving:
- $QQQ relative performance of SPY broke above a key trendline
- and QQQ is now closed above the 200D for the first time since April 2022
- So the technical picture has flipped positive
STRATEGY: VIX matters far more for 2023 returns than EPS growth
Our data science team compiled the impact on 2023 equity returns from variables:
- S&P 500 post-negative year (2022)
- the varying impacts of
- VIX or volatility
- USD change
- Interest rates
- EPS growth
- All of the 4 above, positive or negative YoY
- Data is based on rolling quarters and summarized below
The surprising math and conclusions are as follows:
- most impactful is VIX
- Post-negative year (rolling LTM)
- if VIX falls, equity gain is 22% (win ratio 83%, n=23)
- if VIX rises, equity lose -23% (win ratio 14%, n=7)
- I mean, this shows this all comes down to the VIX
- EPS growth has little impact
- If EPS growth is negative YoY (likely), median gain +14.8% (win-ratio 70% n=33)
- If EPS growth is positive YoY, median gain is 15.5% (win-ratio is 78%)
- Hardly a sizable bifurcation
As the scatter below highlights, we can see the sizable influence of the VIX. Even in all years, the VIX is a key factor:
- in our view, if inflation falls sharply
- and wage growth slows
- Fed doesn’t have to cut, but this is a dovish development
- we see VIX falling to sub-20
- hence, >20% upside for stocks
And as shown below, EPS growth has a somewhat important correlation, but hardly as strong as VIX changes.
- the difference in median gain is a mere 70bp (positive vs negative) post-negative year
- the importance of EPS growth is stronger in other years
STRATEGY: Financial conditions should ease in 2023, driving higher equity prices. Technology, Discretionary and Industrials levered to easing FCI
The “base” case for 2023 should be below. That stocks gained >1.4% in the first 5 trading days, and this portends strong gains for the full year:
- Post-neg year + up >1.4% on first 5 days
- Day 5 to first half median gain is 9.5%
- Full year median gain is 26%, implies >4,800 S&P 500
- 7 of 7 years saw gains.
Those 7 precedent years are shown below.
- the range of full year gains is +13% to +38%
- so, this is a VERY STRONG signal
- the two most recent are 2012 and 2019
- we think 2023 will track >20%
The path to higher equity prices is discussed above:
- core inflation falling faster than Fed and consensus expects
- wage inflation is already approaching 3.5% target of Fed (aggregate payrolls)
- Fed could “dovishly” leg down its inflation view
- allowing financial conditions to ease
- bond market has already seen this and is well below Fed on terminal rate
BASE CASE: The “maths” for what to expect in 2023, post a “negative return” year (2022)
Question: how common is a “flat” year? Our team calculated the data and it is shown below:
- since 1950, there are 19 instances of a negative S&P 500 return year. In the following year,
- stocks are “flat” (+/- 5%) only 11% of the time (n=2)
- stocks are up >20% 53% of the time (n=10)
- yup, stocks are 5X more likely to rise 20% than be flat
- and more than half of the instances are >20% gains
So, does a “flat year” still make sense?
As shown below, these probabilities are far higher compared to typical years:
- since 1950, based upon all 73 years
- stocks are “flat” 16% of the time vs 11% post-negative years — BIG DIFFERENCE
- stocks are up >20% 27% of the time vs 53% post-negative years — BIG DIFFERENCE
- see the point? The odds of a >20% gain are double because of the decline in 2022
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. The list of tickers and their respective themes is shown below.
Communication Services: $GOOGL, $META, $OMC
Consumer Discretionary: $AMZN, $GRMN, $TSLA
Consumer Staples: $BF/B, $KO, $MNST, $PG, $PM
Energy: $DVN, $EOG, $MRO, $OXY, $PSX, $VLO, $XOM
Financials: $AXP, $JPM
Health Care: $AMGN, $HUM, $ISRG, $MRK, $UNH
Industrials: $GD, $JCI
Information Technology: $AAPL, $AMD, $CDNS, $CSCO, $KLAC, $MSFT, $NVDA, $PYPL
Real Estate: $AMT