Powell cited “disinflation” 13 times in Feb FOMC presser (0 in Dec). Fed moved forward goal post = strengthening case >20% gain in 2023.

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Investors were expecting a hawkish Fed post-Feb FOMC and instead equities rallied >1%

Going into this Fed decision day, investors told us anyone “rational” expects the Fed to come out hawkish, particularly given how much financial conditions eased since October:

• Equities were under selling pressure early in the session falling as much as 1% and then sinking further post-Fed decision. But by the end of the day, the S&P 500 closed up >1%
• Despite a fairly hawkish FOMC opening statement and even initial Fed Chair Powell comments (to Q&A), equity and bond markets garnered dovish undertones from the press conference.
• Notably, Powell cited the word “disinflation” 13 times in this press conference. This is a major change in language and tone and shows that Fed is now officially recognizing the growing disinflation forces underway. Recall, in December, the Fed cited “inflation higher (vs Sept)” so this is a massive change. And we, at that time, argued that was a Fed “unforced error.”
• In Dec presser, “disinflation” was used ZERO times by Powell.
• So in 6 weeks, things changed to warrant the exploding use of the word “disinflation” — disinflation signs have been everywhere since October, except in FOMC press conferences.
• Yields fell sharply with 10-yr falling >10bp to 3.41% and VIX tanked further falling to ~17 and the lowest level in 18 months.
• Take a step back, there is a change in narrative taking place and equity investors are now just starting to appreciate this.
• As we have stated for some time, inflation hit a wall in October and has been tanking since. And while some say that the services inflation remains elevated, the reality is housing inflation is set to tank further and goods prices have further to fall. So by mid-year, the trajectory of inflation is lower and Fed and markets are now “course correcting”
• Equities bottomed in 10/12/2022 and the recent expansion of market breadth and broadening participation, in our view, validate a bull market is underway.
• What does this mean for investors? Foremost, 2023 is going to prove to be year of “more opportunity and less crisis.”
• To capitalize on this, investors should focus on sectors that benefit from this combination: (i) falling inflationary pressures and falling interest rates; (ii) valuation expansion potential as inflation tail risk is eliminated; (iii) companies that will see stronger demand as they offer inflation hedging/cost reduction leverage for business, particularly labor costs and (iv) stocks that survive if there is no “depression” or recession.

As we discussed multiple times, the vectors of opportunity are:

• Small-caps $IWM due to positive operating leverage boost and “no depression” risk premia boost

• Technology $QQQ $FNGS as they have less sensitivity to falling PPIs but most correlated to easing FCIs. And they offer the best path for businesses to reduce exposure to rising labor costs.

• Beaten up names with high leverage as the debt burden risks are dimished

• This is looking more and more like 1982 isn’t it? But the “rule of 1st 5 days” shows that 2023 base case is likely >20% rise or new all-time highs this year.

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