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Investors worry Fed playing “whack-a-mole” with stock prices, but if inflation tanks (with wages slowing), FCIs will ease…
Over the weekend, I had a few conversations with clients and one of them observed that while bond market volatility has dropped (which generally is good for stocks), they viewed being “long equities” as a low Sharpe ratio (high risk but high reward) trade:
- while stocks could have upside given promising developments on both inflation and wages
- they worry Fed would be alarmed by a rise in stocks (aka “easing financial conditions”) so Fed could push back hard, or even push harder on hikes
- they also worry that ISMs/PMIs could slip even further, and thus, the US economy is slipping towards a “hard landing”
- this whack-a-mole is why investors see being long as “high risk” (even if there is “high reward”).
But probabilities increasing 2023 a +20% rise for S&P 500, even as consensus sees “flat” stocks prices
Here is what is interesting.
- Our work suggests odds increasing equities will produce >20% gains in 2023.
- So far in 2023, S&P 500 gained +1.4% in first 4 trading days of 2023. Since 1950, this has happened 23 times (of 73 years). Median gain is +17% for full year of those 23 instances with 20 of 23 showing gains (87% win-ratio). This analysis was flagged by our data science strategist, Matt Cerminaro.
- When S&P 500 is negative prior year, this drops down to 8 instances (of the 23). Median gain (of 8) is +23% (+600bp even better) and win-ratio of 88% (only 2002 exception).
- This is another set of analytics supporting equities could rise 20% in 2023. As we highlighted last week, based upon expected drop in market volatility (as Fed becomes “predictable”), S&P 500 likely posts >20% gains (83% win ratio since 1950).
- This is so counter to consensus, which is looking for “flat markets” marked by a steep decline in 1H23, followed by a rally only in 2H.
- The key is will Fed stop playing “whack-a-mole” with markets. And our view is affirmative, if inflation tanks and wage growth eases (as it appears to be). As such, the bond market has it right. The Fed will possibly do +25bp hike in February, and that is it.
- Alan Blinder, former Vice Chairman of FOMC, wrote on Op-Ed Friday noting that inflation has fallen to nearly the 2% Fed target but few have noticed. And he makes the point (that we have as well), that YoY inflation is too “backwards” looking and that when the direction has suddenly changed, it is important to look at 3M or similar annualized data.
- Applying “consensus” +0.25% for Dec Core CPI (on 1/12), 3M annualized core CPI will fall to 2.8%. This is literally in “spitting distance” of Fed’s target and coupled with the softish wage data seen last week, points to far more dovish trajectory for inflation data.
- Hence, we think this points to a Fed that will be more “dovish” vs Consensus in coming months. And in turn, lowers equity and bond volatility. This then means equities can gain >20% in 2023.
Historically, this is a good omen for stocks. Take a look at some work by our data science strategist, Matt Cerminaro, As noted above, there are 23 precedent instances (of 73 years) and the median gain is +17%.
- +17% is nearly 2X any other year
- But if the prior year was a negative year (ala 2022), the median gain rises +600bp to +23%
- Of the 8 instances (>+1.4% plus negative prior year), only 2002 saw stocks decline through YE.
- In other words, if this is like the other 7 years, stocks will do well.
- Notably, 5 of the 8 instances were >20% gains, with gains as much as +38%.
Thus, this is the “base case” for 2023. And this is far stronger than the “flat” 2023 envisioned by Consensus.
And as shown below, the first 4 days has a notable and surprising impact. We have previously written about the “first 5 days” signal, so this is essentially the same:
- markets generally see strong follow through when the first 4 days are positive (see top two rows)
- and if markets are weak in the first 4 days, the opposite is true
December CPI should show inflation has “hit a wall”
And the OpEd by Alan Blinder (last week), affirms our assertion. Investors seem to be willingly ignoring that inflation has collapsed recently.
- part of this is the Street and pundit’s focus on YoY inflation, not looking at recent trends
- Blinder notes that at inflection points, YoY is too slow to see this change
- This has been exactly our point
December CPI will be released on 1/12 (below) and the Street is looking for +0.3% on Core.
- we believe Core CPI could come in as low as +0.10%
- headline is forecast to be +0.0%, or literally zero inflation in December.
- another key incoming data point is U Mich CC 1-yr inflation Jan preliminary
- The Street is looking for flat at +4.4%.
- We think this figure could even be below 4%. This would also be a positive shock for markets.
Dec Core CPI could lead to a 3M SAAR inflation tanking to 2.8% from 4.2% last month
If Dec Core CPI comes in at +0.25% (Consensus), this will lead an absolute tanking of core inflation:
- 3M annualized inflation could fall to 2.8% from 4.2% last month
- The “big inflation” monthly prints are falling off
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 than 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
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
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