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Last week was a test for the S&P 500 uptrend and test was successful…
In our conversations over the past week, few investors are outright constructive on stocks. It is getting and harder and harder to find a bullish investor — many of our institutional investor zooms start by asking “so, does anyone agree with what you are saying?”
Many are glad that specific stocks are rising, but nearly all view that these are idiosyncratic ideas and that the larger trend for stocks remains down. There are many reasons investors remain bearish, we understand that:
- BEAR: Inflation is high and this means the Fed is still waging an inflation war.
- US: Of course, our view is that inflation is falling and the Fed has become data dependent, so the crisis mode of 2022 is gone.
- BEAR: Yield curve is inverted and coupled with Fed hiking means a recession is inevitable
- US: The yield curve is inverted because inflation itself is in backwardation. Inflation is expected to be higher 1Y and 2Y forward vs 10Y out, so this has to show up in bond yields. Also, the high Fed funds of today doesn’t mean rates are this high 24 months later, hence, 2Y can be below FF.
- BEAR: Earnings estimates are falling, hence stocks need to go down. Plus valuations are high.
- US: Stocks bottom 11-12 months before EPS bottoms. As for valuation, ex-FAANG, S&P 500 P/E (2024) is 14.8X. Hardly demanding.
- BEAR: Inflation will come roaring back because China will consume oil. And the Russia-Ukraine war is still raging.
- US: These are inflationary shocks. And the multiple cascading shocks caused the 2021-2022 inflation surge. Oil demand rising is not the same inflation shock.
In any case, you get the picture. Investors are still firmly cautious and overall bearish.
Yet, S&P 500 uptrend looks firmly intact
Take a look at the S&P 500 below. The uptrend since October is intact and equities bounced off the 200-day. So this is another constructive sign.
2009: 5 months after the March bottom, investors still saw this as a “sucker rally”
How many times have we heard pundits call this 2023 rally a “sucker rally” — guess what, this was also happening in 2009.
- In August 2009, 5 months after the March 2009 lows, pundits were calling this “medicated highs”
- So, was 2009 really an “obvious bottom?”
- Nope, many haters of the 2009 lows
- Remember the famous “new normal” arguments about stocks entering a decade of sub-par gains?
- Or the Occupy Wall Street protests? Saying capitalism is dead?
CALENDAR: Key incoming data starting March 10
I want to re-focus on the calendar.
There is lot of incoming economic data this week (durable goods, housing, unit labor costs and ISM) but for the key inflation-related data, there is a bit of a dead spot until early March. As shown below, this really starts March 10th:
- 3/7 10 am ET Powell testifies to Congress Senate Banking Committee
- 3/8 10am ET Powell testifies to Congress House Fin Svcs Committee
- 3/8 10am ET JOLTS Job Openings (Jan)
- 3/10 8:30am ET Feb employment report
- 3/13 Feb NY Fed survey inflation exp.
- 3/14 6am ET NFIB Feb small biz survey
- 3/14 8:30am ET CPI Feb
- 3/15 8:30am ET PPI Feb
- 3/17 10am ET U. Mich. March prelim 1-yr inflation
- 3/22 2pm ET March FOMC rate decision
- 3/31 8:30am ET PCE Feb
BEST GUESS POWELL: Reiterates “data dependence” and +25bp gets priced back into March
Powell is set to testify to Congress this week, starting with the Senate on 3/7.
- recall, many inflationistas are saying +50bp is needed because the January data was so “hot”
- that is the data reactivity of the bond and stock market
- but we expect Powell to emphasize that rates are near neutral now, so there is less of a need to be higher in a hurry
- and now Fed can be data dependent
- by the way, moving to +50bp hikes would be a sizable change in policy and reversal of the slowing and frankly, would be viewed as undermining Fed credibility.
- A +25bp implied is a “dovish” development and would support our thesis of an 8-week rally underway
RALLY: 6 reasons we see a rally next 8 weeks
Here are the reason we see equities gaining in the next 8 weeks:
- The last of the “hot” inflation data was the 4Q ULC (unit labor cost) at +3.2% and beginning next week, will be incoming February economic and inflation data, which we believe will show “softer” jobs and “softer” inflationary pressures. This will reverse, to an extent, the somewhat alarming surge in inflation and jobs data of Jan (part seasonal, part noisy data).
- Fed chair Powell actually kicks off this period with his semi-annual testimony to the Senate Banking Committee and House Financial Services Committee and we expect Powell to reinforce the “data dependent” message. Meaning, +25bp is the path for March FOMC, barring evidence of continued acceleration of inflation. Fed’s Bostic said the same essentially yesterday in his speech.
- The bond market will likely pivot dovish in March. The “hot” Jan inflation data caused the bond market to price in higher odds of +50bp in March and April, and Fed speak seems to be pushing back against that — meaning, Fed is less hawkish than recent move in bonds.
- Falling VIX. If the incoming data tilts the way we expect (“softer”), then bond volatility should fall, which supports a stock rally in March to April. This means VIX could fall, and a falling VIX is supportive of higher equity prices.
- Seasonals are also a strong argument. We have been using the composite of “rule of 1st 5 days” using the 7 precedent years where gains >1.4% in the first 5 days (ala 2023). This composite implied market gains into Feb 16 and a consolidation thru early March (3/7). 2023 is following this pretty closely.
- This same composite now implies March to end of April will be the strongest 8 week period for 2023 with a median gain implied of 7%. If 2023 follows this path, the S&P 500 could reach 4,250-ish by the end of April. By the way, this lines up with the ~4,300 level in the coming weeks.
- I am not sure I agree with those who say the stock market is expensive. I think many cite this as another “confirmation bias” to stay on the sidelines.
- As highlighted earlier this week, ex-FAANG, the P/E (2024) of S&P 500 is 14.8X. And sectors like Energy are 10X and Financials 11X. These are not demanding valuations. And consider the fact that the US 10-yr at 4.0% yield is an implied P/E of a bond of 25X. Yup. The bond market is still far pricier than stocks.
PAYBACK (aka Calendar): Feb = payback, March+April = Fire
As you know, we are using the composite of the “rule of 1st 5 days” as the template for 2023 — this is a calendar template. The other is the breakaway momentum (see note Sunday). And as we flagged earlier this year, Feb is a “payback” month:
- of the 7 precedent instances, Feb is up only 57% of the time, which is worst of any calendar month
- median gain of +0.2% is the worst of any month
- hence, Feb is not a month that investors can arguably see gains
- Feb 2023 sort of validates this template still valid
Next 8 weeks is “buy the dip”
But this same template says March + April should be very good months for stocks:
- win-rate is 100% or 7 of 7 times March is a gain
- Median gain of March and April are the strongest
- Even stronger than January
- Hence, we think the next 8 weeks is a period of “buy the dip”
For those tactically focused, this composite below shows March 7 is the ideal window:
- this coincides with Mark Newton, Head of Technical Strategy, who sees markets chopping here near term
- but this softness is a buy the dip moment, as the next 8 weeks should be among the strongest
VALUATION: Ex-FAANG, S&P 500 P/E is 14.8X, hardly demanding
We hear investors say the market is too expensive. But this is distorted by the higher multiples of FAANG, and we think the higher multiples of FAANG are justified.
- ex-FAANG, P/E is 14.8X
- this is hardly demanding
- Energy is 10.5X, whoa
- so, still think the equity market is expensive?
TECHNOLOGY: Still our favorite Sector pick for 2023
As we noted in our 2023 outlook, Technology is our top sector pick, which we expect to be led by FAANG.
- Technology and FAANG are now established meaningful breakouts as shown below
- this after sliding down the slope of hope in much of 2022
- this reversal has fundamental arguments
TECH EPS: Bottoming before the overall market
The two best performing sectors YTD (as of end of Feb) are:
- FAANG +1,180bp outperformance (vs S&P 500)
- Technology +210bp
- Defensives have been terrible, despite those arguing for a recession
- Tech/FAANG EPS has been slightly better than the overall market
- Thus, leadership is coming from groups with EPS bottoming
7 of 14 sub-groups in Technology seeing upward bias in EPS revisions
Take a look at 2023 EPS in the 14 sub-groups (GICS 4) of Technology.
- Half, or 7 of 14 are seeing upward bias in 2023 EPS revisions
- So, those saying Technology is a “sell” are overlooking that EPS momentum is turning 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
Real Estate: $AMT