FLASH COMMENTS:
In a week that was packed full of macro headlines from Speaker Pelosi’s trip to Taiwan, a host of Fed speakers talking down the “Dovish Pivot” interpretation of Chair Powell’s post FOMC press conference comments, a huge upside surprise in the employment report, and a huge 15% surge in the most shorted stocks, I took a small step back from the front lines of watching the macro headlines and was deeply immersed in my monthly deep dive into my single stock quantitative selection model that is called ERM. During this review period, I look at more than 2,000 U.S. stocks, with a keen focus on their individual earnings revisions indicator (ASM), and I look at their charts to get a sense for how things are trading.
I get a lot out of these reviews as I get deep into the weeds and into my process, which has a big influence from earnings revisions. So, I effectively put on my blinders and go from macro and micro, which allows me to have a different perspective than other strategists who only fly at the 50,000-foot level. My key takeaway from my week of looking at single stocks is that profit forecasts for Corporate America remain too high, they will need to be lowered, and this will likely take time, especially for areas that are sensitive to economic cyclicality.
Thus, despite the magnitude of the ongoing bounce in the S&P 500 off its June lows, my outlook has not only stayed the same, but also my high conviction level has actually increased. My main points which I have been discussing quite often over the last 6-8 weeks remain in place and are as follows: 1) The ongoing equity market rally is counter trend (dead cat bounce) and is nearing its peak and roll over; 2) Growth, both defensive and offensive, looks relatively better than cyclicality; 3) It remains premature to look past the Fed; 4) The U.S. economy is decelerating and fears of slowing have not reached their maximum level; 5) Forward expectations for corporate profits are too high and most certainly will need to be lowered, especially names that are more sensitive to cyclicality; 6) Based on my work, there has neither been a price nor fundamental capitulation yet, but they will both likely happen at some point in front of us; 7) THE equity market bottom, either a clear test of the June lows near 3600 or lower, has not been reached yet; and 8) My work still suggests to sell rallies and not buying dips.
Over the last several months, I have been commenting quite a bit about how my earnings revisions work continues to weaken and is nowhere near max pessimism yet. Importantly, I want to make two points quite clear based on my analysis — 1) There is earnings risk, and my research shows it is going to be more than “in name only” as the analyst community has yet to begin serious downgrades that are going to be needed; and 2) Although my outlook for the corporate profit reality is NOT for a deep yr/yr contraction, it does not mean that the market’s expectations will not become that negative and overshoot reality, which has happened quite regularly over the past 30 years.
Regardless of my outlook, it is my view that investors really need to ask themselves a couple of key questions: 1) What is going to shift the market’s views to an improvement and acceleration in profit growth going forward? and 2) What is going to drive valuation multiple expansion?
For me, there are three main potential catalysts — 1) A supply side change in energy/commodities that causes crude to fall closer to $60, and the most obvious event here is a Ukraine/Russia peace deal; 2) A Fed easing cycle of 50-150 basis points; and 3) Earnings expectations fall dramatically, valuation multiples compress 2-3 points, and the S&P 500 falls to 3000-3200, which basically just lowers the bar on everything and allows the future to be better.
I am not going into the full debate and provide all my support details in this note, but I will leave you my quick thoughts — A) I have given up hopes of a peace deal but am on alert for an aggressive pivot to all views if one suddenly occurred; B) Regarding the potential for a Fed easing cycle, I have had many heated conversations with my network of experts/sources/colleagues/clients, and my current view is that the emergence of inflation relative to any period over the last two decades makes this more challenging and less likely unless either the economy falls off a cliff or something breaks, which if one of these occurred would likely mean that a volatility spike would happen and equity markets would be falling quite hard before the easing; C) At the moment, the easiest way to get earnings up in the future and multiples to expand is to reduce the current period to much lower levels. More on these in coming notes, and please feel free to shoot me an email pushing back/agreeing on any or all of these. I would love to hear from you.
Thus, I am retaining my ongoing bearish stance and am targeting 3600-3500 as my next downside target, and remain a rally seller, cautious, and looking for better opportunities on the horizon.
For investors that need to be invested and need to focus on relative performance, my work still shows that traditional growth, both defensive and offensive, are likely the areas that will have the most relative winners as more cyclical-related areas will get the brunt of the downward estimate cuts over the next 3-6 months. For cyclicals, I would recommend single stocks to outperform other cyclicals for your exposure. Most of them are higher quality as poor operators and management teams will likely not have any get out of jail free cards coming from any new stimulus for quite some time.
Bottom line: My work is still flashing danger and advises that oversold bounces should be viewed as counter trend and that they will likely fail. So, strategic investors should opportunistically use them to sell into, raise hedges, and reposition. Tactical traders can play when my aggressive tools (HALO-2 and V-squared) are favorable as they have generally been since late June, but know any strength is likely a bear market rally that fails so always keep an eye on the exit door.
MAIN CLIENT ISSUES
- Confusion about the Fed.
- Headline inflation either has peaked or is about to, but what does that mean for policy going forward?
- Why are equity markets still moving higher?
- Earnings from an absolute basis have not been a disaster, but not seeing exciting growth prospects going forward.
SPECIFIC CLIENT QUESTIONS
Any single stocks stand out from the S&P 500 from your deep dive ERM review?
MY ANSWERS
Any single stocks stand out from the S&P 500 from your deep dive ERM review?
The following are a mix of Contrarian and In-motion favorable names that looked favorable and particularly interesting:
LIN, ALB, BLL, AVY, GD, NOC, LMT, RTX, WM, CMG, AMZN, COST, BF/B. STZ, KDP, KO, PM, CPB, LW, MDLZ, IDXX, ISRG, ALGN, CVS, LH, HCA, ADBE, CRM, MSCI, NDAQ, and AMT.
I am also including the updated book of favorable names with a market cap greater than $2.5 billion as a good place to start looking for new ideas.
Fundstrat Global Portfolio Strategy – Estimate Revision Model – Positive Rated Names