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This was a big week for inflation data with both critical April CPI (5/10) and PPI (5/11) coming in softer (more favorable details.) In this “game of inches” market, we see this as incrementally favorable for those positive.

Foremost, 3 things happened this week that support the Fed’s decision to “pause”:
– soft-ish core CPI readings, particularly given “hotter” component was used cars
– core PPI came in at +0.2% (vs Street +0.3%) and food CPI now down to 2.5% YoY
– forward indicators point to future softness including Manheim April cars down -4%
– and AAA gasoline now down $0.20 from mid-April highs
Food has been one of the stickier CPI components still at +7.7% YoY in the latest CPI report. Yet, Food PPI is down to a mere 2.5%. I mean, isn’t this a yawing gap? Obviously, great for profit margins, but also perhaps a sign that food inflation is set to cool sharply. This is similar to 2015-2017 period and as shown below, you get the picture, food is deflating.
On balance, we think this lends more fundamental credibility to the Fed “pause” — that is, skeptics might have argued last week the “pause” was solely due to regional bank stress, but this week’s data supports the idea current policy/other factors are driving an easing of inflation.
Fed funds futures show the odds of a June hike have fallen to 1.5%, and were as high as 20% earlier this week. Even bond yields fell this week, So the collective picture from this week’s data certainly seems to have convinced markets. In fact, even US govt yields fell in a convincing way, the 10-yr is now back to 3.39%, which is the level pre-April jobs report.
One might think that this doesn’t mean stocks need to rise, even if the data has moved towards the “soft landing” camp. But keep in mind, investors have de-risked and de-levered to a significant extent. We covered much of this recently including the massive swing to short S&P 500 futures contracts and the surge in ICI retail cash balances.
Today, we want to highlight the collapse in FINRA margin debt. The recent trough margin debt is now $607 billion:
– this is down -35% since late 2021 and a decline of $330 billion from peak
– during GFC, the FINRA deleverage was $216 billion, so already surpassed
– margin debt as % market cap now 1.59%, matching “dot-com” 2002 25-year low
In other words, while this might be a marginal positive shift on fundamentals, there is a far greater positioning shift ahead, if the data ends up proving to be “soft landing”

BOTTOM LINE: Still a game of inches, but the bull case continues to gain

Market direction in 2023 feels like a “game of inches” (Al Pacino in Every Given Sunday, see YouTube below). After last Friday’s surge post-April payrolls, the equity market has leaked lower over the beginning of the week (flat really). But overall, the bulls have the upper hand as the S&P 500 is up 8% YTD.

REGIONAL BANKS “OUCH” BUT STICKING WITH IT: Of our recommded trades, the regional bank tactically rally has not yet materialized. But we are not at the give up stage yet. Regional bank arguably benefit from both a “pause” and from the bleed lower in interest rates. But the stocks are under selling pressure. Even today, JPMorgan CEO Jamie Dimon $JPM suggested on BloombergTV there should be a temporary ban on short-selling. I normally do not support such bans, but perhaps this is a case that makes sense, given the popularity of 0DTE options, etc.
FAANG STILL SEE >50% IN 2023 AI TINA: As for FAANG, we still believe these will be core outperformers in 2023. I am just leaving a conference in Istanbul and even here, there is wide discussion of the need for AI and automation. These tools are supplied by FAANG $META $AMZN $AAPL $NFLX $NVDA $GOOGL $MSFT. Shouldn’t these rare stocks have a P/E premium?
INDUSTRIALS: We see outperformance still driven by the trough in PMIs. And a Fed pause means financial conditions could ease further, aiding a recovery in PMIs.

Short-sellers are important for market function, but it could be possible that 0DTE options and social media are making harmful bear raids easier. Thus, I am taking seriously Jamie Dimon’s suggestion of a short-selling ban.

FOOD PPI LEADS FOOD CPI: This is a gap that will narrow

The yawing gap between food PPI and CPI is startling. As shown below:

Food PPI is down to 2.5% YoY
Food CPI still stuck at 7.7% YoY
Look at the 2015-2017 period
you get the picture, food will be deflating.

MACRO: Pause is reinforced, as Fed fund futures sees 1.5% of hike in June down from last week

The odds of a hike have fallen sharply this week and as this weekly chart shows, the odds are down to 1.5%. This was 12% last week and as high as 20%

We think the bar has been raised for a June hike, given the combo of:

(i) spreading regional bank stress;
(ii) known contagion on the (unlikely) default of US debt;
(iii) visible progress on slowing inflation and labor markets and
(iv) known lags of monetary policy.
This seemed to be the message from the May FOMC meeting last week and the key being the risks for regional banks if financial conditions remain too tight.

But cuts thereafter are puzzling. One explanation is that this is a single figure, but there are probabilities of wider outcomes. If the Fed has to make emergency cuts, how does that get priced into these futures contracts.

We also see the pause playing out in government yields. The 2Y and 10Y yields are down this week visibly.

ECONOMIC CALENDAR: Key May data is inflation and ISM, and April was overall “tame”

Key incoming data May

~~5/1 10am ET April ISM Manufacturing (PMIs turn up)~~ Positive inflection
~~5/2 10am ET Mar JOLTS~~ Softer than consensus
~~5/3 10am ET April ISM Services~~ Tame
~~5/3 2pm Fed May FOMC rates decision~~ Dovish
~~5/5 8:30am ET April Jobs report~~ Tame
~~5/5 Manheim Used Vehicle Value Index April~~ Tame
~~5/8 2pm ET April 2023 Senior Loan Officer Opinion Survey~~ Better than feared
~~5/10 8:30am ET April CPI~~ Tame
~~5/11 8:30am ET April PPI~~ Tame
5/12 10am ET U. Mich. April prelim 1-yr inflation
5/12 Atlanta Fed Wage Tracker April
5/24 2pm ET May FOMC minutes
5/26 8:30am ET PCE April
5/26 10am ET U. Mich. April final 1-yr inflation
5/30 Conference Board Consumer Confidence

Key data April

~~4/3 10am ISM Manufacturing Employment/Prices Paid March~~ Tame
~~4/4 10am ET JOLTS Job Openings (Feb)~~ Tame
~~4/7 8:30am ET March employment report~~ Tame
~~4/12 8:30am ET CPI March~~ Tame
~~4/12 2pm ET March FOMC Minutes~~ Tame
~~4/13 8:30am ET PPI Marc~~h Tame
4/14 7am ET 1Q 2023 Earnings Season Begins Better than feared
~~4/14 Atlanta Fed Wage Tracker March~~ Semi-strong
~~4/14 10am ET U. Mich. March prelim 1-yr inflation~~ Hawkish
~~4/19 2:30pm ET Fed releases Beige Book~~ Tame
~~4/28 8:30am 1Q23 Employment Cost Index~~ Semi-strong
~~4/28 8:30am ET PCE March~~ Tame
~~4/28 10am ET UMich April final 1-yr inflation~~ Hawkish

STRATEGY: FINRA Margin debt shows positioning is far more bearish than most appreciate

One might think that this doesn’t mean stocks need to rise, even if the data has moved towards the “soft landing” camp. But keep in mind, investors have de-risked and de-levered to a significant extent. We covered much of this recently including the massive swing to short S&P 500 futures contracts and the surge in ICI retail cash balances.

Today, we want to highlight the collapse in FINRA margin debt. The latest figure shows margin debt is now $607 billion:

this is down -35% since late 2021 and a decline of $330 billion from peak
during GFC, the FINRA deleverage was $216 billion, so already surpassed
margin debt as % market cap now 1.59%, matching “dot-com” 2002 25-year low

In other words, while this might be a marginal positive shift on fundamentals, there is a far greater positioning shift ahead, if the data ends up proving to be “soft landing”

This time series really shows the extent of de-leveraging. The level of margin debt to market cap is at 1.59% and same as dot-com trough

so any decisive “soft landing” data will shift positioning far more dramatically

STRATEGY: Focus on Industrials, a week to make a tactical positive bet

Both the ISM PMI and S&P Global US PMIs are released on Monday:

ISM Manufacturing PMI has been better than consensus.

Actual 47.1 vs Street 46.8 and last month 46.3

S&P Global US PMIs has come in slightly lower than consensus, but remains above 50.

Actual 50.2 vs Street 50.4 and last month 50.4

Whenever PMIs bottom (see below), Industrials tend to bottom. This first chart shows rolling change for US PMIs and US Industrials returns.

This distribution table puts this in a clearer light. When PMIs are rising and from low levels, Industrials see strong gains.

Since 1948, when PMIs are over 50 and are rising (n=60), Industrials see positive forward 6M and 12M gains of 85%/95% of the time with median gains of +12.6%/21.5%, respectively.

Those are very favorable risk/reward and high absolute return opportunities.

Industrials are oversold vs S&P 500 on 20D %-change, with a z-score of -1.2.

The top chart is the relative price ratio of Industrials vs S&P 500
The bottom is the z-score of the 20D % change.
The most recent 4 times this was seen, Industrials staged strong rallies vs the broader market.

This is not that different than the signal we highlighted two weeks ago regarding FAANG/Technology. And we know that FAANG powered higher in the past two weeks

And Industrials are the most oversold vs other sectors, particularly against Staples.

34 GRANNY SHOTS: Updated list is below:

The revised 34 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.

There is only 1 stock appearing in 4 of 7 themes: $MSFT.

There are 3 stocks in 3 of 7 themes: $XOM $AAPL $CDNS.

Consider these the stocks that are the most commonly seen as “grannies” and thus, the higher quality ideas. To be a granny, a stock must be in at least 2 of 7 themes.

Communication Services: $GOOGL, $META

Consumer Discretionary: $AMZN, $GRMN, $TSLA, $ULTA

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

Energy: $DVN, $OXY, $PSX, $VLO, $XOM, $MPC

Financials: $AXP, $FISV

Health Care: $AMGN, $HUM, $ISRG, $MRK, $VRTX

Information Technology: $AAPL, $AMD, $CDNS, $KLAC, $MSFT, $NVDA, $PYPL, $FTNT, $NOW, $ON

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34 Granny Shot Ideas: $GOOGL, $META, $AMZN, $GRMN, $TSLA, $BF/B, $FISV, $MNST, $PG, $PM, $DVN, $FTNT, $OXY, $PSX, $VLO, $XOM, $AXP, $MPC, $AMGN, $NOW, $ON, $ULTA, $VRTX, $AAPL, $AMD, $CDNS, $KLAC, $MSFT, $NVDA, $PYPL, $HUM, $ISRG, $KO, $MRK

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Odds of a hike dropped to 1.5% post-CPI and post-PPI