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We are continuing our visit with clients in Japan. The overall mood of investors remains cautious for understandable reasons. They don’t want to fight the Fed and they remain concerned that stocks have not discounted the expected decline in 2023 earnings.
- Earnings contraction remains a consensus bearish argument.
- The 2023 outlooks from Wall Street make this same argument as highlighted from BCA below, and similar views from others. Consensus sees stocks bottoming in 1Q2023 or so to 3,000-3,200 on contraction in earnings.
- But the consensus expected decline in earnings is not guaranteed. The USD rose ~20% in 2022 subtracting ~8% from EPS and this becomes a tailwind in 2023 if USD softens — will it add +5% in 2023?
- And companies have been managing costs in 2022 as plunging CEO confidence triggered caution. We previously highlighted the plunge in CEO confidence is the fastest ever and like 2016 and 2018 triggered by monetary policy, not business conditions.
- And the overwhelming driver of Fed policy and market views is inflation. While investors think inflation remains sticky, the soft Oct CPI argues it is falling quickly. And in coming 5-7 days, we get two critical Nov inflation reports for PPI and CPI and we think those will be repeatably soft.
- Inflationary pressures are fading quickly, evidenced by gasoline round tripping to start of 2022. The easing of supply chains. Even housing cooling rapidly. And the only sticky component might be labor markets.
- But is it possible that JOLTS is overstating the tightness of jobs markets? Our data science team highlights that key economic reports like JOLTS and labor reports are being made with a plunging response rate by companies. The most recent JOLTS only had a 31% response rate down from 44% in 2021 and 68% in 2012. It is during this time that openings exploded to 12 million from 7 million. But this seems to be less reliable, no?
- Taking the combined of the above, we think there remains greater downside risk to inflation and labor markets (JOLTS is arguably overstating the tightness of labor, see below). Thus, Fed could change its views regarding the path of rates. And therefore markets would change their positioning.
- These are all probabilities, of course, but that is where we differ from consensus. And if this comes down to inflation, this makes a comparison to 1982 relevant.
- Stocks bottomed in August 1982, two months before Fed Chair Volcker considered “ending the war on inflation.” In the 3 months from the August low, stocks rose 40% and recovered the entire 27 month bear market. And stocks bottomed two months before the Fed considered ending the inflation war.
- And we don’t think the end of the inflation war in 2022 is the Fed cutting rates. It is when Fed and markets see sufficient progress in inflation to remove the upside risks to higher rates. We think this could happen as early as the November CPI report. This will be released on 12/13.
And if November CPI is soft, we think this will support a strong YE rally. Admittedly, a 10% move between now and YE seems a stretch given the S&P 500 is ~4,000 but we think such a move is possible if November CPI (reported 12/13) is soft matching the contour of Oct CPI. And the broader point is we see stocks having positive skew given the cautious positioning of investors and the possibility of very favorable incoming inflation reports.
Sell-off since Monday but uptrend still intact and Friday PPI likely most important data point this week
Equities sold off sharply to start this week with a ~2% decline. Nobody needs a reminder that investors remain hypersensitive to “hot” economic data because this pushes the Fed towards “higher for longer” — and the strong Nov ISM Services falls into that category.
- As the chart below shows, the general uptrend since early October remains in place
- The key to market direction remains the trajectory of inflation and several incoming reports are key
- 12/9: PPI (Nov) –> Street looking for Core +0.2% (vs last month +0.0%) –> critical, expect soft
- 12/9: U Mich inflation (Dec prelim) –> 1-yr 4.9% (4.9% last month) –> important, no view
- 12/13: CPI (Nov) –> Core +0.3% (vs 0.27% last month) –> critical, expect soft
We believe probabilities favor a continued downside break in inflationary data, repeating the soft October CPI report
- In turn, given the cautious investor positioning, further evidenced by the >1.7 TRIN reading (flagged by Mark Newton), there is an assymetry to soft inflation data
- Softer inflation is downside to Fed hawkishness, and investors remain risk-off. This is why we see a positive risk/reward dynamic into YE.
- The Nov jobs report (reported Fri last week) also flagged that the response rate to surveys issued by BLS (to create economic reports) has plunged in the past year. It was 44% for the payrolls report, the lowest in 30 years.
- Our data science team, led by tireless Ken, also noted that the response rate for JOLTS survey has plummted to a mere 31% from 44% in 2021 and 68% a decade ago.
- This plunge in JOLTS response rate comes at a time when JOLTS data shows job openings exploded from 7 million to more than 12 million.
- Here is my question. How confident can we be that there are >12 million job openings when the response rate is down to 31% and even in 2012, only 50% of large corporations continued to respond to JOLTS surveys?
- Linkedin economists, in a Harvard Business Review report, argued the ratio of job openings to available workers is 1:1 not the 1.7:1 as reported by JOLTS.
- The plunge in response rates, true for CPI, BLS jobs and JOLTS, highlights there could be more error in these economic reports. And contemporaneous measures argue that both inflation pressures and the labor market are weaker than these “hard” reports show.
- This means investors should assign greater odds that the true trends in labor and in inflation are diverging from official reports. Think about that — 31% of cos responded to JOLTS from 44% in 2021, but JOLTS shows an explosion of openings. And many questions remain about multiple city listings, etc.
- Thus, one could argue the skew is for inflation to break to the downside. And thus, the Fed and its expectations for inflation are too sticky. Thus, Fed could turn sooner than consensus expects.
- This is why we think markets could over-react to the PPI and CPI reports in coming weeks. But this overreaction would be a positive move.
- The decline in real rates (real 10Y yields 1.2% vs 1.74% a month ago) and somewhat stable VIX (~20) remain relatively supportive of stocks
Looking above, in the next 5 trading days, two critical pieces of inflation trends will be revealed. There is the risk of noise in this data, but the trends, in our view, remain favorable on inflation as we discuss below.
Markets are not “fighting the Fed” if inflation is falling
And this takes us to a key dynamic. If inflationary pressures are falling, the market is not fighting the Fed:
- if inflationary pressures are easing, the markets will move ahead of the Fed
- while investors seem to focus on key words like “pivot” or “cut rates,” we think this is secondary
- when the inflation war is over, the key is whether the US economy is in healthy shape
- the strong ISM Services highlights the US economy remains resilient and it is our central view that inflation is tracking softer than equity consensus believes
- the bond market certainly sees far less inflation risk, evidenced by the falling 2Y yields and the fact the 2Y yield is ~50bp above the current Fed funds upper limit — this suggests the Dec hike could be the last
PERSPECTIVE: Response rate for key economic reports are plunging = Fed future forecasts less reliable = “soft data” arguing inflation falling far faster
There was considerable chatter last Friday on the BLS November employment report, which showed jobs growth, strong payrolls growth, but was somewhat at odds with contemporaneous other measures of the labor market.
- the gap was sizable between the establishment survey (non-farm payrolls +263k) and household survey (-138k)
- but there were several economists that noted the unusually low response rate (by corporations) for the November survey
- the initial response rate was 44.8%
- well below other years as shown below
- the response rates for JOLTS, it turns out, is far worse down to 30% (see below)
The response rates for CPI, NFP and JOLTS are plunging and collapsed in past year
Our data science team, led by tireless Ken, pulled together the response rate for various surveys. The response rates for CPI, NFP and JOLTS are shown below:
- CPI reponse rates is down to 37.7% and plunged in past 12 months
- NFP is 44.8% but has been relatively steady in the past 12 months (see shaded)
- But wow. Look at JOLTS where the response rate utterly collapsed from 44% to 31% in 12 months
JOLTS: Job openings surge from 7mm to 12mm while response rate collapsed from 44% to 31%
It is the JOLTS report that really caught my eye. Look at the divergence:
- JOLTS response rate has collapsed from 44% to 31% since 2021
- at a time when job openings surged to 12 million from 7 million
- think about that…
- how accurate is the surge in 5 million additional job openings, when there are 1/3 fewer respondents?
The BLS published a white paper on the survey process and respondent rates in 2012. The node tree below highlights some surprising statistics:
- in 2012, the initial response rate was 68%, or more than double the 31% today
- of “multi-establishment” firms (large cos), only 51% responded after the first survey
- JOLTS is longitudional, meaning they survey same respondents over 24 months
- if in 2012, only 51% of large entities reponded after first survey (when 68% was response rate), how low is the response rate now when response rate is 31%?
- think about that
JOB OPENINGS: There might be far fewer job openings than JOLTS implies = Fed could change its future path
The cornerstone of the Fed “higher for longer” is a job market that needs to cool. And the Fed has repeatedly referred to the JOLTS data showing 1.7 openings for every available worker.
- but what if JOLTS is overstated and less reliable?
- the above data shows only 31% initial response rate, down from 44% at start of 2021 and 68% a decade ago
- many critics have argued JOLTS is inaccurate because of multiple city listings for the same job
- and what about work from home? or business office closures? it seems like possibilities for a mess
- and recall, Linkedin economists argue the JOLTS data is overstating the tightness of the labor market
- their data (see below) shows the ratio is probably closer to 1:1 based on their network of applicants and employers
FED “FACE VALUE”: The plunge in response rates for JOLTS implies investors put too much faith taking Fed at “face value”
The most important takeaway for me is that investors are putting too much faith on taking the Fed at “face value”
- if JOLTS sampling size is shrinking (response rate falling), then the JOLTS report might be less indicative of true underlying job opening trends. This suggests that Linkedin data or others, showing a softer market might be a better measure.
- In other words, the “tail” would point to a softer jobs market, not stronger
- Hence, would imply Fed could make a dovish adjustment when this gap is potentially resolved.
INFLATION: Media coverage is beginning to highlight the cooling/falling inflation
In general, we think inflation risks are to the downside, not upside. The Washington Post article below is highlighting that signs of cooling inflation are becoming more evident.
Inflation for some items are falling like a rock.
And when looking at trends in core inflation, which tends to be less volatile, the only real remaining inflationary component is housing:
- but as Powell noted last week, the Fed realizes base effects are causing housing CPI to lag the actual changes in the marketplace
- thus, if November CPI shows similar repeatable trends as October CPI, then consensus could similarly become more confident
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:
- $AAPL in 4 of 6 portfolios
- $GOOGL $MSFT in 3 of 6 portfolios
- $AMZN $META in at least 2
- This reinforces our favorable view of FANG in 2H2022
37 Granny Shot Ideas:
Communication Services: $GOOGL, $META
Consumer Discretionary: $AMZN, $AZO, $GPC, $GRMN, $ORLY, $TSLA
Consumer Staples: $BF/B, $MNST, $PG, $PM
Energy: $CVX, $DVN, $EOG, $PSX, $XOM
Financials: $ALL, $AXP
Health Care: $AMGN, $HUM, $UNH
Information Technology: $AAPL, $AMD, $AVGO, $CSCO, $KLAC, $MSFT, $NVDA, $PYPL, $QCOM
Materials: $CF, $FCX, $LIN
Real Estate: $AMT, $CCI, $EXR