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On the eve of two critical events, Nov CPI and Dec FOMC, equities are down 6 of last 7 days
As markets enter the final weeks of 2022, investors are doubting equities can rally into YE, particularly after the Nov core PPI (12/9) came in at 0.38% (vs Street +0.2%) given how hyper-sensitive markets are to incoming data.
But as we look into this critical week of 12/12, we think probabilities favor stocks responding favorably overall. Yes, a good Nov CPI and better than expected FOMC presser are important, but this is not the only dynamic:
- PPI inflation is falling like a rock. the 3M annualized post-Nov core PPI is now 2.69% — think about that, 2.69%. It was >11% in March 2022. So the +0.38% Nov PPI might be above Street, but the trend is obvious.
- Nov Core CPI of 0.3% or so is a major break in trend, as it would be two “soft” CPIs consecutively. Recall, Powell at the Brookings Institution (11/30) noted inflation has not been predictable as soft CPIs were followed by higher readings. As we noted in prior analysis, the Oct CPI had repeatable components driving lower CPI readings.
- Equities have fallen in 6 of the last 7 sessions. This is approximately the 9th time in 2022 this has happened. As the charts below highlight, this has been followed by strong bounced 10D and 1M later, with median +3.1% and +4.9%.
- The FOMC press conference doesn’t have to be entirely hawkish. In fact, there might be a “dovish” modification in language.
- Recall, since March 2022, the second paragraph of FOMC alludes to “the war and related events are creating additional upward pressure on inflation” — logical since global inflation surged parabolically post-invasion.
- Russia war-inflation is “dead” — long live inflation. Oil and wheat are now 21% and 13% below the pre-invasion prices (the prices before the parabolic surge) and the war is still ongoing. The inflation war is dead.
- Removal of this language, in our view, would also allude to a potential shift in the Fed view on inflationary drivers. As we highlight below, 9 of 10 fundamental inflationary drivers of US inflation have either turned to deflation or cooled substantially. The only real remaining driver is “revenge travel” spend but things like labor and housing are already cooling.
- And economists are increasingly vocal about the notion the Fed will capitulate on the 2% inflation target. The FT op-ed by Olivier Blanchard, French Economist, argues a better target is 3%-4% both from the perspective managing policy rates and also for consumers and wage earners. This would be a tremendous shift and change the path of markets.
- The latest Goldman Sachs client survey shows of the 10 possible trades for 2023, the plurality of clients are “short S&P 500” — yup, the consensus trade for 2023 is short equities. Think about that.
- Credit has outperformed equities and as the regression below shows, the rally in HY OaS spreads (options adjusted) point to S&P 500 at 4,200. This means the S&P 500 has upside without a further rally in credit. But we think credit can further rally if Nov CPI is soft.
- Lastly, recall last week we highlighted the S&P 500 is the worst performing equity market in 2022 (outside China zone). Does this make sense? The US inflation has been better than others. US has secured energy supplies. The Fed is further along.
Taken in totality, we think there remains fundamental momentum to the idea that inflation is falling faster than expected. And this in turn should lead to a less hawkish Fed path in 2023. The most prominent example is the language in the FOMC statement about Russia-Ukraine war and inflation impact. This is just not correct any longer as both are in outright deflation.
PPI not entirely a disaster…
While Nov PPI came in somewhat “hot” the 3M trend is certainly positive:
- 3M annualized inflation is now 2.69% and as shown below was >11% in March 2022
- and both CPI and PPI 3M annualized inflation is falling
Nov CPI hopefully is soft and is a break in pattern (per Fed)
Nov CPI is released 12/13 and we think the most important takeaway will be the trend in inflation surprises is shifting to flat/lower. This is a break in pattern (see below).
And would also directly address Powell’s statement at the Brookings Institution on 11/30 (below).
REVERSAL: Down 6 of 7 days has been a turning point in 2022
Market have fallen 6 of the last 7 sessions. And given up the surge post-Brookings Institution.
Is this justified? Well, the Nov PPI and Nov payrolls report were “hot” so investors are nervous into this coming week. But look at 2022:
- the declines of 6 of 7 days have been followed by solid market rallies.
- there is some overlap as some 6 of 7 days string together
But as shown below, the 10D and 1M returns in 2022 post-6 of 7 have been positive.
- median 10D/1M gains of +3.1%/+4.9% and win ratios of 67% and 81%
- these are well above average, implying good risk/reward this week
WAR INFLATION IS DEAD, LONG LIVE INFLATION: Oil and Wheat prices have fallen BELOW pre-invasion prices…
This is shocking, at least to me. Oil and Wheat are now solidly below the pre-Russia-Ukraine war levels:
- the entire inflation surge has been erased
- and oil/wheat are 21% and 13%, respectively, below these levels
And as below highlights, these were accelerants to CPI surging. In the US, CPI exploded to 9% following the war.
And since March 2022, the FOMC has alluded to the war as a primary factor putting additional upward pressure on inflation:
- this is what could be removed in this month’s statement, or in the future
- and arguably would signal a shift in Fed arguments around sustained inflation
- after all, the war is still ongoing but prices have completely reversed
9 DRIVERS OF 2022 INFLATION: 4 SUPPLY/5 DEMAND
In our view, there are 9 primary drivers of inflation in 2022 as highlighted below.
And with the fall in oil/wheat along with the tanking of housing, inflation is falling on both ends.
- that is, inflation both short-cycle and long-cycle (sticky) are cooling rapidly
- this is an inverse of inflation spiral
- it is an inflation de-spiral
- goods inflation is slowing
- supply chains normalized
- jobs market is softening, but maybe not fast enough
- longer cycle like housing are also slowing
And prices for freight have almost completely round-tripped (Asia to USA) and this is even as China remains under lockdown.
And now rents are visibly softening. Powell and Yellen even noted this gap between market-based measures and official lagging CPI data.
INFLATION TOLERANCE: 2% might be reconsidered
Another positive possible development is the Fed rethinks 2% target. As the OpEd by Economist Blanchard notes, it has benefits to both policymakers (easier to target) and for households. And 3%-4% is not necessarily a burden for households.
CONSENSUS: Short S&P 500… you know what that means
As Goldman’s client survey shows, the most popular trade for 2023 is short S&P 500. I mean, that speaks for itself. When consensus can cite a litany of reasons to be bearish, we need to appreciate lots of bad news is priced in.
HY OAS: Says S&P 500 should be closer to 4,200 without further easing of FCI
We tend to look at HY and equities as cousins of performance. And as the spread analysis below highlights:
- stocks are cheap relative to where HY spreads are sitting
- HY could further rally if Nov CPI is soft or if Dec FOMC is less hawkish
- hence, one could argue more upside for stocks from here
Why is the US essentially the worst stock market in the world? With the weakest bounce?
Arguably, the US has best weathered the trifecta of global turmoil–global inflation, surging oil and China zero COVID–among any major nations. This is evidenced many ways but consider:
- Fed has raised interest rates +400bp in 2022
- yet, the US economy continues to produce solid real GDP growth and employment has held up
- and inflation has been falling visibly
Yet, despite the obvious robustness of the US economy, the US equity market is among the worst performers YTD:
- peak to trough, the US fell -28% and as shown, is the worst of any major nations except for those 3 Asian nations Hong Kong (-53%), China (-40%) and Korea (-36%).
- and the US rise from the low is only +10% which is dwarfed by other nations including Germany which has surged +20%. Germany only fell -27% peak to trough, which is less than the US
RETRACEMENT: US only recovered 29% of decline, while Europe 45% to 77% retracement
This also puzzles me. This is looking at retracements, or what share of the decline has been recovered:
- the US has only recovered 29% of the decline (10% recovery after a 28% decline)
- yet, other major nations have seen 45% to 77% retracements including Germany (54%), Japan (47%), UK (77%) and even Brazil (38%)
- to me, this is not consistent with the US having the best economic outcome arguably
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