As my calendar begins to refill and my activity levels start returning to normal after my couple weeks of dealing with some things, I find it interesting to be both reading/hearing from other forecasters/analysts as well as interacting with clients.
From other forecasters/analysts, I am hearing talk about how good earnings have been for the quarter, that the equity markets are in great shape, lots of technical strength, the economy will avoid recession, and that the Fed is close to aggressively shifting back to accommodation.
My discussions with clients are quite different. They are neither overly bearish nor uber bullish. Most have less cash than during 2H22, are cautious and concerned, with a high percentage of frustrated, confused people. Although there are ongoing debates and questions regarding the overall macro backdrop, there is now a higher percentage of time being spent on sector and style allocations, as well as single stock discussions.
The next couple of weeks and into the end of 1H23 are going to be filled with lots of potential hand grenades, including the upcoming May FOMC meeting, the last half of the ongoing earnings season, fears of a slowing U.S. economy, a resurfacing of problems in the banking sector, and the headlines coming from inside the Beltway regarding the debt ceiling negotiations.
My work still signals caution. I continue to look for opportunities when sectors or single stock names have over reactions and am still trying to look for the elusive evidence to turn back to bullish. It still looks like patience will be needed.
The below are my updated macro/market thoughts:
- Labor-market strength may be waning somewhat, but signs of outright weakness and broad-based job losses are still not flashing, which keeps the Fed’s inflation fight challenging.
- Core inflation readings are not falling at the same pace as before and have caused some uncertainty about its path in the coming quarters, which lowers the probability of the market’s dovish Fed expectations.
- I remain in the “Fed is higher for longer” camp, and my forecast for the terminal rate is still 5.25-6.25%. I am keeping this under review for another lowering in the coming months if the fears of a credit crunch accelerate.
- NO EASING — Despite the recent problems in the banking industry, my view remains that once the Fed does pause it will likely keep policy unchanged for an extended period. I expect Chair Powell to reiterate this at the upcoming May FOMC meeting.
- The economy looks headed towards a shallow recession, and then an extended period of sluggish growth.
- Corporate profit expectations remain too high and need to be lowered, as there are strong headwinds.
- Importantly, the immediate upside potential for the S&P 500 still appears limited, at best, while considerable downside risk remains for equity investors.
- From a positioning standpoint, economically sensitive areas/names are looking the riskiest based on my key indicators, while secular growth ideas look relatively favorable.
- Single stock opportunities are sparse, but they are slowly increasing. The general theme is higher vs lower quality and larger vs smaller cap.
Bottom line: My work continues to signal that downside risk is elevated and investors need to be mindful of equities moving lower.
There has been little change in my bigger-picture thoughts and medium/longer-term key indicators, which have been the basis for my longstanding unfavorable equity market view.
It should be noted that several of my preferred tactical metrics flipped to unfavorable earlier this week. When they roll over, the S&P 500 has historically had limited upside at best, and have a high probability of consolidating/pulling back. Hence, tactical risk has considerably risen, and investors should be positioned for a challenging period for at least the next 4-6 weeks, and maybe longer.
Consequently, I reiterate my negative view on the equity market and urge caution to investors. Based on my analysis, there is still a significant amount of risk for equity investors, and it is advisable to remain vigilant and patient.
For investors who must be fully invested or focus on relative performance, my analysis is still suggesting that a barbell strategy of cash, defensive positions, and select larger cap, higher quality, secular growth names will outperform. My earnings revision work signals that cyclical areas will face significant downward estimate cuts, as I have previously discussed.
GENERAL CLIENT QUESTIONS/CONCERNS/TOPICS
- A fair amount of skepticism about the health of the ongoing equity rally.
- I do not hear an excessive amount of bullishness or bearishness.
- Investors are focusing on relative positioning.
- Although macro discussions are still happening a lot, more time is being spent on sector, style, and single stocks than has been the case in over a year.
- What is happening with earnings is a big topic of interest.
SPECIFIC CLIENT QUESTIONS
- What is your Equity Exposure Indicator showing? How much equity exposure do institutional investors have right now?
- Any thoughts on the 1Q23 earnings season?
- Some have been commenting that earnings are now improving. Do you agree with this? What is your ASM line showing?
- What is HALO showing? Is it flashing risk?
- What are your preferred aggressive tactical indicators showing?
- Any single stock names that are “growthy,” showing improving ASM?
What is your Equity Exposure Indicator showing? How much equity exposure do institutional investors have right now?
My indicator of institutional equity exposure has continued to remain around neutral after reaching extreme negative levels during 2H22.
My Equity Exposure Indicator (EEI) has been methodically stair-stepping higher since reaching extreme negative readings twice during 2H22, which flashed a contrarian bullish signal. The current reading is just above neutral and does not really suggest any definitive signals, but it does suggest that the fuel provided by being underexposed is no longer present.
Any thoughts on the 1Q23 earnings season?
As stated prior to the earning season began, my expectations were that the results would NOT show that the profits for Corporate America were collapsing, and they would likely be better than the low expectations that were consensus. In my view, the results have come in just as I was forecasting. The final tally will likely show the S&P OEPS fell between 5-6% year over year.
There was some buzz that the earnings season was coming in quite strong after some early reports from the big money-center banks, which skewed the results. Based on my analysis, the aggregate statistics show that profit growth and margins continue to be under pressure and that forward estimates remain too high. The remaining three quarters of 2023 are all expected to be better than 1Q23’s results, which seems perplexing to me since the slowing of the U.S. economy is only gradually occurring and likely to pick up steam during 2H23. My work strongly suggests that 2H23 will fall to flat, at minimum, and more likely end up being down 7-15% year over year.
Some have been commenting that earnings are now improving. Do you agree with this? What is your ASM line showing?
NO, earnings are NOT improving. The rate of change of the deterioration has been slowing somewhat as the domestic economy remains resilient. However, this does not appear to be the beginning of a new sustainable ASM uptrend.
As readers likely know, I have been looking for an extreme negative reading in my proprietary ASM indicator for the overall market as a critical leading signal that it was time to shift back to being bullish. Why? Because my research shows that EVERY major equity bottom since 1990 was preceded by my ASM indicator reversing from an extreme low. Over the last 4-6 weeks, an unprecedented occurrence has shown up in my indicators — the S&P 500 cap weighted ASM has begun to roll up while the S&P 1500 equal weighted ASM struggles and looks to be headed lower.
Since 1990, a divergence like this has never happened, as shown in the chart below on the left. When zooming in a bit by using the right chart, one can see the current readings more clearly. Diving into this anomaly, I found that less than 10 Large Cap, mainly Technology/MAGA/FANG names, are the cause of this variance and if they are excluded, the two metrics come back into alignment. In my view, this supports my ongoing views that overall earnings are still too high, that Large Cap, Higher Quality, and Secular look relatively better while SMid, Lower Quality and Cyclical looks at-risk.
What is HALO showing? Is it flashing risk?
My preferred tactical indicator (HALO, blue line below) for the index has provided many significant tactical reversal signals since 4Q18, which all ended up rewarding investors, continues to be value-added. This key metric rolled over on Monday at the close, which is what I have been looking for to return to tactically bearish and once again be fully aligned with my ongoing unfavorable medium-term outlook. While this indicator is negatively sloped, it will be challenging for the S&P 500 to post gains, especially with my even more aggressive indicators also flipping to negative.
What are your preferred aggressive tactical indicators showing, and what are your most aggressive tactical indicators saying?
My most aggressive tactical tools are now unfavorable as of Monday’s close. This strongly suggests that S&P 500 upside potential is limited at best, and more likely that a consolidation/pullback is likely to occur until they make their next bottoms. With HALO also rolling over as discussed earlier, the probability of weak S&P 500 performance for the next 2-6 weeks seems highly probable and realigns with my longstanding bearish medium-term view that continues to target the October lows, at minimum.
Any single stock names that are “growthy” showing improving ASM ?
Yes, two names that I have been highlighting since my recent ERM review earlier this month are CMG and ISRG.
As shown below, both names have had positive ASM inflections from deep negative readings, which is historically a contrarian bullish signal. The bars for stocks have also been favorably making a series of higher red bar lows over the past several years. Both names are a bit tactically overbought and might need a short duration consolidation/pullback, but my work suggests that they are “buy the dip” candidates on any weakness.