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Fed Chair Powell speaks today at the Economic Club of DC at 12pm ET. And investors are cautious in front of his appearance, as many expect Powell to come out “hawkish” relative to his dovish Feb FOMC presser last week. The rationale being the strong Jan jobs report signals renewed concerns the Fed has to do more, not less. This is evidenced in the fact that Fed fund futures are now pricing in 5.1% by June 2023, compared to 4.8% or so just last week.

Our contrarian take is the Fed will actually stick to the more “dovish” message. While the Street believes this has very low (like zero) probability, here is our reasoning:

Fed risks credibility if the message swings 180 degrees from an official meeting just 7 days earlier. This is the opposite of predictable and understandable
It took the Fed 3 great inflation reports (below expectations) before Fed acknowledged “disinflation” — so will one strong jobs report cause Fed to suddenly want to accelerate hikes?
There are many problems with this Jan jobs report, including the fact that much of jobs dynamics in Jan is a function of how “seasonal layoffs” playout. That is, several economists note that if hiring is muted in Dec, Jan can see fewer layoffs. But this “seasonally adjusted” shows up as strong jobs. That is not reality.
Moreover, wage growth remains muted and while it seemed to jump in Jan, does this fit with the reality of companies reporting layoffs, and weak topline and even non-JOLTS showing a soft jobs market? So the Fed cannot even be certain that Jan labor markets really strengthened.
Several non-voting Fed members talked about how strong Jan jobs justified raising rates faster. Recall, Kashkari is the Fed member who in late December said “there was no signs of progress on inflation.” Sorry, the Fed members have a growing reputation of looking “backwards” at data (recall the December SEP issues).
Finally, investors are positioned cautiously into this Powell appearance. The Nasdaq is down 3% in the past 2 days. S&P 500 down 2% in the same timeframe.
Mark Newton, our Head of Technical Strategy, believes the S&P 500 possibly made its short-term low yesterday and is set to rally to 4,200 or higher in the coming weeks.
This is a contrarian take but is consistent with the fact that Powell could be dovish.

Bottom line, our take is Powell is probably more dovish than consensus expects.

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

Materials: $NUE

Real Estate: $AMT