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The Fed’s FOMC announced its May rate decision deciding upon a +25bp hike and a shift towards an evenutal pause by modifying the policy statement “in determining the extent may be appropriate” (removing “the committee anticipates that some additional policy firming may be appropriate”).
- FED ACTION IS A “MAKE”: In essence, this was a “dovish” +25bp rate hike as the Fed believes rates are sufficiently restrictive. But equities saw a sizable sell-off. I listened to the press conference twice, and Powell stated multiple times that the FOMC sees policy rates “about near” where they need to be to contain inflation. And any further adjustments would be in reaction to incoming data, aka data dependence. This policy rate is essentially at the FOMC’s target rate from its March “dot plot” (SEP, or Summary of Economic Projections) of 5.1%. And they saw further tightening delivered from QT (balance sheet unwind) and from the fallout from the regional bank crisis.
- EQUITY MARKET REACTION IS A “BREAK”: Initially, this “dovish take” was the market’s initial reaction as the S&P 500 rallied +30 points (+0.70%) peaking at 4,148 (2:40pm ET). But soon thereafter, shed 1.5% and closed down for the day at 4,091. There were 5 points during the press conference (see below) where the S&P 500 responded negatively to Powell’s statement, during the Q&A session.
- WHAT DID POWELL SAY? 3 COMMENTS TRIGGERED WEAKNESS: And we labeled statements that were made in proximity to these market sell-offs. This is not to say those exact words triggered the market reaction, but you get the idea. This is what was being said at each point in the press conference.
– 2:40PM ET “A decision on a pause was not made today”
– 3:06PM ET “inflation (not) come down…quickly…. not…appropriate to cut rates”
– 3:18PM ET “Support for 25bp rate…VERY strong…. did talk about pausing, but not…this meeting”
- In other words, the apparent triggers for market weakness were in reaction to commentary around a “pause” — one view is that equity markets wanted a clearer statement about a pause, not a conditional view about data dependence. And Powell also multiple times expressed his view that he does not see a recession as the base case, even if Fed staffers believe this.
- BOND MARKET VIEWED DOVISHLY: Overall, bond markets took the Fed comments dovishly, to the extent that interest rates 12M and beyond (2Y, 5Y, 10Y, etc) fell during the FOMC press conference. The fact that interest rates actually ticked down is a contrast to his expectations that “rates would be held at this level for an extended period of time.” As listed below, none of the US rates beyond 3 months even remotely reflects the Fed’s statement (yields are lower).
– Fed funds 5.125%
– UST 3M 5.181%
– UST 12M 4.634%
– UST 2Y 3.805%
– UST 10Y 3.336%
- Even bond market volatility (MOVE Index) fell yesterday. So the overall reaction in the bond market was benign, relative to the weakness seen in stocks. Unfortunately, regional banks fared poorly as well. Again, seems that the Fed might be amplifying the credit tightening associated with balance sheet issues at regional banks.
- FUTURE INFLATION SOFTER (OUR VIEW): While investors were seeking more clarity, Powell also explained his reasons for not being crystal clear of a pause. Foremost, he noted that inflation remains too high and that inflation trends are volatile and even the key category “core services ex-housing” has been unchanged, per his view. But as we noted in our PCE commentary last week, the trend in MoM of Core services ex-housing visibly softened. We will have a better sense when April CPI is released next week. Perhaps this is when investors will see “pause” as not only the base case, but a sustained case.
- LABOR MARKET (TO SOFTEN, OUR VIEW): Similarly, Powell noted that he saw the labor markets as very strong currently. That is true when looking at unemployment rates. Yet, at the same time, he similarly noted that he doesn’t see strong labor as the “root cause” of inflation. In other words, while he would like to see a cooling of labor markets, he is not seeing it as essential to quell inflation. This Friday’s employment report for April will be telling, but as we highlighted yesterday, DeepMacro sees a 10% miss.
- REGIONAL BANK TIGHTENING (IF WORSE, FED PAUSES): On the regional bank crisis, the Fed stated that they are not sure to the magnitude of the impact of the credit tightening associated with the regional bank crisis. And some color would be available when the senior loan officer survey is released on 5/8. But at this time, it is best to view that regional bank impact as doing some tightening, but “it’s quite impossible to have a precise estimate.”
BOTTOM LINE: This did not prove to be the make or break, but we now see Fed “pause” as the base case
The Fed base case is now “pause” and only signs of strengthening data would justify a hike. This is a positive development, in my view. While I was hoping to see stocks finish strong, the pause is ultimately a positive on the margin. Moreover, the drop in yields shows that bond markets are not necessarily believing/pricing in the “higher for longer” as Powell noted several times.
- There is an understandable period of market choppiness developing. The next major catalyst is the April jobs report. And there, a downside read would be constructive. But more comments coming Thu.
Yields fell, which is somewhat counter to the drop in stock prices. A drop in yields is supportive of rising P/E multiples.
ECONOMIC CALENDAR: Key May data is inflation and ISM, and April was overall “tame”
Key incoming data May
5/1 10am ET April ISM Manufacturing (PMIs turn up)Positive inflection 5/2 10am ET Mar JOLTSSofter than consensus
- 5/3 10am ET April ISM Services
- 5/3 2pm Fed May FOMC rates decision
- 5/5 8:30am ET April Jobs report
- 5/5 Manheim Used Vehicle Value Index April
- 5/10 8:30am ET April CPI
- 5/11 8:30am ET April PPI
- 5/12 10am ET U. Mich. April prelim 1-yr inflation
- 5/12 Atlanta Fed Wage Tracker April
- 5/24 2pm ET May FOMC minutes
- 5/26 8:30am ET PCE April
- 5/26 10am ET U. Mich. April final 1-yr inflation
- 5/30 Conference Board Consumer Confidence
Key data April
4/3 10am ISM Manufacturing Employment/Prices Paid MarchTame 4/4 10am ET JOLTS Job Openings (Feb)Tame 4/7 8:30am ET March employment reportTame 4/12 8:30am ET CPI MarchTame 4/12 2pm ET March FOMC MinutesTame 4/13 8:30am ET PPI March Tame
- 4/14 7am ET 1Q 2023 Earnings Season Begins Better than feared
4/14 Atlanta Fed Wage Tracker MarchSemi-strong 4/14 10am ET U. Mich. March prelim 1-yr inflationHawkish 4/19 2:30pm ET Fed releases Beige BookTame 4/28 8:30am 1Q23 Employment Cost IndexSemi-strong 4/28 8:30am ET PCE MarchTame 4/28 10am ET UMich April final 1-yr inflationHawkish
STRATEGY: Focus on Industrials, a week to make a tactical positive bet
Both the ISM PMI and S&P Global US PMIs are released on Monday:
ISM Manufacturing PMI has been better than consensus.
- Actual 47.1 vs Street 46.8 and last month 46.3
S&P Global US PMIs has come in slightly lower than consensus, but remains above 50.
- Actual 50.2 vs Street 50.4 and last month 50.4
Whenever PMIs bottom (see below), Industrials tend to bottom. This first chart shows rolling change for US PMIs and US Industrials returns.
This distribution table puts this in a clearer light. When PMIs are rising and from low levels, Industrials see strong gains.
- Since 1948, when PMIs are over 50 and are rising (n=60), Industrials see positive forward 6M and 12M gains of 85%/95% of the time with median gains of +12.6%/21.5%, respectively.
- Those are very favorable risk/reward and high absolute return opportunities.
Industrials are oversold vs S&P 500 on 20D %-change, with a z-score of -1.2.
- The top chart is the relative price ratio of Industrials vs S&P 500
- The bottom is the z-score of the 20D % change.
- The most recent 4 times this was seen, Industrials staged strong rallies vs the broader market.
- This is not that different than the signal we highlighted two weeks ago regarding FAANG/Technology. And we know that FAANG powered higher in the past two weeks
And Industrials are the most oversold vs other sectors, particularly against Staples.
34 GRANNY SHOTS: Updated list is below:
The revised 34 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.
- There is only 1 stock appearing in 4 of 7 themes: $MSFT.
- There are 3 stocks in 3 of 7 themes: $XOM $AAPL $CDNS.
Consider these the stocks that are the most commonly seen as “grannies” and thus, the higher quality ideas. To be a granny, a stock must be in at least 2 of 7 themes.
Communication Services: $GOOGL, $META
Consumer Discretionary: $AMZN, $GRMN, $TSLA, $ULTA
Consumer Staples: $BF/B, $MNST, $PG, $PM, $KO
Energy: $DVN, $OXY, $PSX, $VLO, $XOM, $MPC
Financials: $AXP, $FISV
Health Care: $AMGN, $HUM, $ISRG, $MRK, $VRTX
Information Technology: $AAPL, $AMD, $CDNS, $KLAC, $MSFT, $NVDA, $PYPL, $FTNT, $NOW, $ON
34 Granny Shot Ideas: $GOOGL, $META, $AMZN, $GRMN, $TSLA, $BF/B, $FISV, $MNST, $PG, $PM, $DVN, $FTNT, $OXY, $PSX, $VLO, $XOM, $AXP, $MPC, $AMGN, $NOW, $ON, $ULTA, $VRTX, $AAPL, $AMD, $CDNS, $KLAC, $MSFT, $NVDA, $PYPL, $HUM, $ISRG, $KO, $MRK