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This week is the start of 4Q22. Since Jackson Hole, both Fed and markets have priced in a significant increase in Fed tightening and these actions have raised concerns about financial accidents and worsened by Russia-Ukraine tensions. The Fed would like to see both labor markets slow (JOLTS, in particular) and meaningful progress on inflation (“hard” data like CPI, PCE, etc). With the Fed determined to fight inflation, investors naturally wonder how equities could even manage to rise in 4Q.

While this certainly seems a steep hurdle, consider the following:

foremost, soft/leading indicators are pointing to a significant slowing in inflationary pressures even as “hard” CPI/PCE have not yet reflected this
while Fed and markets are focused on the “hard” data, we believe this divergence will be resolved by CPI showing these improvements
the Fed is watching labor markets and job openings, in particular, and this should be weakening
but because so many job openings are “poaching” (per Fed study), job openings could soften while not hurting employment as badly
this latter point is the conclusion of the Fed working paper (see last week) and a support for a soft landing
the yield curves could be stabilizing and in fact the 10Y less 3M is steepening and has not inverted
this is obviously curious and flies in the face of those saying Fed is engineering a recession
do markets now sense that current path is on track to quash inflation? Possibly
while market technicals are abysmal, so is investor sentiment and an inflection in inflation would reverse both sharply

Soft data shows progress on inflation

There has been visible progress in slowing inflation in the “soft” data but this has yet to appear in “hard” reports yet. But take a look at this simplified table comparing key “soft”/leading indicators of inflation:

ISMs both showing meaningful rise in “% reporting lower prices paid” and supported by regional PMIs
Consumer inflation expectations have fallen sharply in past few months
U Mich 5-10-yr inflation at 2.7% is now BELOW the 50-yr avg of 2.97%
While CPI headline and core are only modestly improving, the % items in outright decline in prices is now 47%
and even market-based inflation breakevens for 1-yr forward have fallen from 5.6% since start of year to 1.7%
we realize investors are tired of this, but the soft data and hard data cannot diverge indefinitely

LABOR: Lots of incoming data this week…JOLTS should weaken again

The economic calendar for this week is below and we highlighted the labor-related components. The Fed wants to take pressure off wage growth and this obviously means employment needs to weaken:

of these, the most important, in our view is the JOLTS survey
this is a measure of job openings and the Fed often cites the 2.0 (openings/available worker) as a key metric

The leading indicators to JOLTS, indeed labs and Conf board help wanted index (HWOL) both show a pronounced decline in job openings in the past few months.

And as we highlighted last week, the HWOL has a particularly high correlation to JOLTS. Take a look at the nearly identical monthly changes:

HWOL for August declined -0.8%

This implies:

JOLTS should come in at 11.149 million
Consensus is 11.075 million
Does this mean a negative surprise? Not entirely clear
as the jobs/worker ratio is set to fall to 1.85
that is progress

And most importantly, consumer inflation expectations are quickly approaching normal levels (long-term expectations):

U Mich 5-10yr expected inflation back down to 2.7% versus 50-year average of 2.97%
long-term expectations are actually below long-term averages

Notably, Democratic-leaning respondents see far less inflation:

both 1-yr ahead and next 5-10 years
this divide in responses is somewhat surprising

SENTIMENT: Bearishness has soared, arguing skew for positive data response

And take a look at the evolution of sentiment below. The % of bears has surged in the past quarter and this is what sets up for assymetry. If incoming data shows progress on Fed goals, and hence Fed does less, this is where sentiment will shift sharply.

YIELD CURVE: Since Jackson Hole, yield curve steepening…

For those expecting a recession, the yield curve 10Y less 3M is pointing the opposite direction.

as shown below, the 10Y less 3M curve has actually steepened

And as the NY Fed published decades ago, the 10Y less 3M has the best track record for predicting recessions:

at the current spread of 58bp
this implies 10-15% probability of a recession
of course, this could be different as the Fed is raising rates and giving forward guidance
but as the Fed paper discusses, the 10Y less 3M was particularly astute at spotting recessions during the 1970s-80s
that was the inflation episodes

And looking below, the 10Y less 3M has been good at spotting recessions in modern times as well.

JPMorgan Fixed Income strategists similarly note that the steepening of the 10Y less 5Y curve bears watching. While early, they note this curve was a risk-on indicator during the inflation decades.

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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