The ongoing debt ceiling negotiations and lack of a deal between the White House and the GOP continues to dominate the overall equity markets and creates ripples with each headline that hits the tape. Also, a big factor that has everyone’s attention is AI and the top 10 technology names that have had an upward surge in their stock prices. Indeed, the outsized impact of these stocks on the weighted S&P 500 has caused some to suggest that the index has begun a new bull market, and that there is talk of investors feeling the need to put money to work in fears of missing out on additional gains. Over the last week, some competitor sell-side strategists have either tempered their bearishness or actually flipped to more constructive solely on the S&P 500’s popping its head over 4200 and creating the appearance that a clear upside breakout was imminent.
I read and hear about the cases for upside potential, and almost all of them are centered around the technical analysis/price momentum of the weighted S&P 500 or NDX and that the sentiment/positioning is still quite bearish. I have asked clients who are bullish to make their case for significant and sustainable upside using additional points, and most have a hard time doing so. The ones who make the attempt comment on the economy being resilient and that the earnings revisions backdrop has marginally improved. Some will make a justification to me that major downside is unlikely, but do not really provide compelling evidence on why they expect a 10-15% move above 4200.
Conveniently, very few bring up valuation, that the weakest economic quarters are likely still in front of us, that there is a lack of evidence that core inflation is coming down on its own, and that the Fed is not likely to start easing soon or provide 200bps of cuts over the next year without something major and negative for markets happening first. I will not even harp on the fact that the consensus expects double-digit earnings growth for 4Q23 and CY24, along with operating margins surging up towards their all-time highs that were reached during 4Q21 earnings (which were reported during 1Q22.)
Does any of this mean that the S&P 500 cannot continue moving higher driven by the growing FOMO in AI-related stocks and technicals? NO. Importantly, however, does my research and reading of the macro backdrop support a broad based healthy upward advance? My answer to this question is also NO.
Although historically I don’t spend as much time commenting on and forecasting what the Fed may or may not do, over the last year I have done so because my views have tended to be quite different than the markets. I have been and continue to be in the “higher for longer” camp, and I still believe that the battle against inflation will be hard fought and take time. The release of the May FOMC meeting minutes has many points within it that continue to support my longstanding view. A couple of highlights:
- The committee appears divided over whether additional interest-rate increases are necessary.
- Emphasis was on communicating a data-dependent approach, but that this should not be taken as a sign that rate cuts are coming.
- Policy markets saw rate cuts as unlikely.
- Forecast is for a mild recession starting in 2H23.
The bottom line for me is that the path of monetary policy is likely to be bumpier and more extended than what is currently priced into markets, which has implications for the economy, forward profit expectations, and valuation among other things.
Late last week, I did a webinar discussing my 2H23 Outlook (a replay is available here), and the below are the key takeaways:
Considerable Risks Remain
The Road Ahead Looks Challenging
The below are my updated macro/market thoughts:
- Labor market strength may be waning somewhat, but signs of outright weakness and broad-based job losses are still not flashing, which keeps the Fed’s inflation fight challenging.
- Core inflation readings are not falling at the same pace as before and have caused some uncertainty about their path in the coming quarters, which lowers the probability of the market’s dovish Fed expectations.
- I remain in the Fed is higher for longer camp and my forecast for the terminal rate is still 5.25-6.25%. I am keeping this under review for another lowering in the coming months if the fears of a credit crunch accelerate.
- NO EASING — Despite the recent problems in the banking industry, my view remains that once the Fed does pause it will likely keep policy unchanged for an extended period. I expect Chair Powell to reiterate this at the upcoming May FOMC meeting.
- The economy looks headed towards a shallow recession, and then an extended period of sluggish growth.
- Corporate profit expectations remain too high and need to be lowered as there are strong headwinds.
- Importantly, the immediate upside potential for the S&P 500 still appears limited, at best, while considerable downside risk remains for equity investors.
- From a positioning standpoint, economically sensitive areas/names are looking the riskiest based on my key indicators while secular growth ideas look relatively favorable.
- Single stock opportunities are sparse, but they are slowly increasing. The general theme is higher vs lower quality and larger vs smaller cap.
GENERAL CLIENT QUESTIONS/CONCERNS/TOPICS
- Despite the S&P 500’s attempt to break above 4200, there remains a reasonable amount of distrust about the ongoing equity rally.
- Almost everyone wants to know what I am hearing about sentiment from others as they are skeptical that the tone is still uber bearish as highlighted by competitor trading desk commentaries.
- I still am not hearing any excessive amounts of bullishness or bearishness.
- Investors continue to want to spend more time discussing how to position.
- There were some value managers that have started nibbling on banks and energy acknowledging that their respective bottoms may not be in yet.
- There is still a lot of interest about what is happening with forward earnings expectations.