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Our latest “Inflation Dashboard” has been updated and is attached
In 2022, the inflation “crisis” has made investors solely focus on “danger” not “opportunity”
I am on my way to Tokyo/Osaka for a few days, traveling with SMBC Nikko, which is our business partner in Japan. Japan is one of my favorite countries to visit. The nation has a distinct and charming culture, art in the food and general pride among its citizens that is impressive.
- Japan is also an impressive nation of savers. The household wealth of Japan is $25 trillion, ranking #3 in the world (USA and China) and 50% more wealth than Germany.
- It might surprise many but Asia equity markets are overall 30% of the global trading and market cap share.
- This is our first visit since 2019. Prior to the pandemic, John Bai and I travelled to Japan twice a year spending almost two weeks a year with SMBC Nikko and their clients.
And as we prepared for our trip, the Japanese word for “crisis” was shared with me by two folks I work with closely:
- Brian O’Day who noted that Williams Inference logo was the Chinese word “crisis” and is comprised of two key words (see below)
- And by sheer coincidence, tireless Ken (quad lingual Ken) had mentioned the Japanese word for “crisis” is “kiki” which in kanji (Japanese) is shown below.
The words are same in Chinese and Japanese. Notice the interesting construction of “crisis”? It is two words combined:
OPPORTUNITY: S&P 500 closed >200D second consecutive day = massive technical recovery
As many in the markets like to say, “price is the final arbiter.”
- for much of 2022, our view that inflation would fade faster than consensus was a battle against massive market liquidations and growing fundamental concerns
- but as the chart below shows, the S&P 500 has managed to claw its way back above the 200D moving average (4,062) and has held this level for two consecutive days
- in the “crisis” of 2022, this has not happened (see below), so this is a break in pattern
And Ryan Detrick @RyanDetrick of Carson Group highlights, recovering the 200D has positive forward implications. Per Ryan:
- only 13 times since 1950, S&P 500 below 200D for >6 months and recaptures 200D
- 3M later: 11 of 13 times higher, 6.7% avg gain
- 6M later: 12 of 13 times higher, 12.2% avg gain
- 12M later: 12 of 13 times, equities higher 12M later with avg gain +18.8%
- Overall, a positive signal
- The only real blight in this is January 2002. This was the only failure.
- Looking back at GFC, this recapture of 200D did not happen until June 2009
- Looking back at pandemic, this recapture did not happen until Nov 2022
- Food for thought.
STRATEGY: What works if inflation crisis is broken? Tech + Small-caps + High P/E + Heavily Shorted
Here are some thoughts about what could work into YE.
Foremost, for stocks to work into YE, the inflation crisis has to be broken. That is, we think the Nov CPI (12/13) will finally convince investors inflation is falling faster than expected. Falling like a rock.
If so, we see the following things changing in consensus expectations:
- yields fall as markets see lower “terminal fed funds” and falling risk premia = 10Y to 3.5% or lower
- mortgage rates fall even as well as there is “excess spread” in 30Y fixed rate mortgage which is historically 150bp above 10-yr yield. Thus 30Y mortgage = 5% not 6.5%
- USD weakens as markets see Fed pivot
- EPS expectations rise as weaker USD reverses 20% rise in USD in 2022, which subtracted 5-8% EPS
What types of stocks work?
- heavily shorted names rally
$AMC $CNK $ARKK $COIN $CCL $WYNN $KWEB
- high P/E stocks which are down 90%-98% get “rented” to be down only 60% from highs
$ZM $CRWD $SHOP
- Technology stocks, which have been hardest hit due to higher rates (lower P/E) surge
$QQQ $AMZN $MSFT $NFLX $SOX $GOOGL
- small-caps rally as investors see cyclical recovery
$IWM $ANGI $HOG $SIX $TPX
These are representive tickers and not stock recommendations.
POWELL: Post-Brookings implied a major change in Fed “playbook” coming
In my view (not necessarily rest of team at Fundstrat nor Tom Block), my overwhelming takeaway from the Powell comments at Brookings Institution is:
- the Fed might be signaling it is preparing to move away from its “hurry up” and even from its “higher for longer”
- even widely followed “Fed whisperer” Tim Duy noted “Powell decision not to push against FCI…was dovish”
- to me, this is a big deal
4 KEY TAKEAWAYS: Post-Brookings, there is plenty of hints of a possible change coming
We sent out an INTRADAY ALERT to Fundstrat clients on Wed post-Powell at Brookings Institution. And in reviewing the interview and transcripts, I found 4 important hints that point to a possible change in Fed “playbook” for inflation:
- first, Powell was self-identifying the great uncertainty of the path of inflation and therefore path of monetary policy. This is important because equity investors are taking as “gospel” that the Fed will move to >5% and stay there for some time
- second, Fed has hinted that “two months” of good inflation reads is a break in pattern. As we noted Wed, Fed in its prepared remarks noted that downside CPI months have been followed by “hot CPI” months. But we expect Nov CPI to possibly be as soft or even softer than Oct. A break in pattern
- third, Powell noted “market rate of new leases is a timelier indicator of overall housing inflation” — this is a major change from Fed. Previously Fed has said “hard” data has been more important. This is a shift towards looking at leading or “soft” data
- fourth, Fed reiterated multiple times a call for risk management — “if you’re waiting for actual evidence that inflation is coming down, it’s very difficult not to overtighten”
Collectively, this is a material change in how the Fed is potentially viewing and interpreting incoming data. In other words, a change in reaction function that could be significantly more dovish.
- thus, we don’t think equity investors should be shrugging off Powell’s views as same as before.
Take a look at the actual quotes from Powell.
FORECASTS: “We have to be humble and skeptical about forecasts” (read as including Fed dot plots)
INFLATION: “down months…have often followed by renewed increases” (Nov CPI will BREAK pattern)
TIMELIER INDICATORS: Powell noting “new leases” timelier (read as less sole reliance on lagging “hard data”)
RISK OF OVERTIGHTENING: Risk management as inflation is at the end of the train
STRATEGY: November CPI likely breaks the 3 most consensus views towards our central view
If someone asked me where my view differs most sharply from consensus, it is the following:
- CONSENSUS: inflation “sticky” and will take years to fall to Fed target
- CONSENSUS: Fed won’t slow hikes until inflation ~2% or something breaks
- CONSENSUS: US economy tipping into a recession
- TAKEAWAY: Consensus is bearish and sees no reasons for stocks to sustain a recovery until AFTER a recession.
- Inflation already breaking to downside and next few CPI prints are 0.2-0.3%, or ~3% annualized.
- Fed soon will see “sustained signs” of falling inflation rates and playbook will change. Fed last hike might be December 2022.
- US economy has been incredibly resilient and soft landing on tap, driven by a major softening of labor markets but not necessarily rise in unemployment.
- TAKEAWAY: So divergent from consensus, when consensus shifts towards this view, stocks will see “near vertical” rally
Our view for 2022 was 1H would be “treacherous” but in 2H, our view for markets is favorable. And given the risk-off positioning of institutional investors (see note from Sunday/Monday) and given the extreme bearish retail sentiment (AAII, etc), there will be an abrupt market adjustment higher.
STRATEGY: Do you see the setup into YE?
So do you see the setup? It all comes down to whether inflation is convincingly cooling. The job market certainly is.
Sure, there are challenges still ahead but many of these are getting better now…
- EPS estimates –> too high? maybe but markets bottom 11 months ahead of EPS
- Labor market is tight –> this is no longer true
- Fed drives economy “off the cliff” –> yes, if Fed keeps looking at “hard data”
- Recession risk –> yes
STRATEGY: Given the above, we see possibility of S&P 500 reaching 4,400-4,500 by YE
We think this rally has more support compared to the June “false pivot” rally to 4,325 (see below).
- thus, we see S&P 500 rallying above that level towards 4,400-4,500
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