While 10-yr yields and Fed Funds barely budge post-Jackson Hole, equities decline sharply = countertrade. U Mich survey shows Republicans primarily see “sticky” inflation.

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The tape feels vulnerable. But as Helene Meisler, TA, likes to say, “nothing like price to change sentiment”

• and post-Jackson Hole, investors have become very bearish

Equities sold off sharply post-Powell’s speech at Jackson Hole (JH) on Friday (8/26). The Jackson Hole speech is not the only macro development, as Friday also saw hawkish rhetoric from the ECB and negative development on the Russia-Ukraine war (as noted by Vital Knowledge). But investors took Friday to become even more negative on the outlook for both the US/global economy and for equities.

But we view this as a far over-reaction. Why? Here are a few key points:

• the Fed spoke of “pain to households and businesses” and this is what became the focus for investors
• but this reflects the Fed’s desire to quash inflation without risk of “flare up”
• post-JH, implied YE 2022 Fed funds rose only 4bp vs +90bp post-June FOMC
• post-JH, US 10-yr rose 5bp compared to +50bp post-June FOMC
• U Mich August Final Consumer Surveys released and show inflation expectations still falling
• U Mich bottom 25th percentile 1-year inflation expectations at +0.9% are below the 20-year average of +1.2%
• Democratic respondent 1-year inflation fell to 3.8% from 4.3% two months ago.
• Republican respondent 1-year inflation still high at 6.9% but down from 7.8% two months ago
• In other words, Republican-consumers see inflation as a far bigger problem
• thus, while Fed implies a “high bar” to be convinced inflation is back to target, surveys show inflation expectations re-anchoring solidly
• hence, we think investors over-reacted to Friday’s JH speech

YE 2022 expectations for fed funds rose 4bp Friday and Sunday (see below) to 3.66%. Compare this reaction to the post-June FOMC (when markets went into a tailspin):

• the market reaction is relatively muted

If expectations for Fed policy thru YE 2023 barely changed, why did stocks fall so much?

And even rates expected through YE 2023 barely moved post-JH as shown below.

• So while the Fed spoke of “pain to households and businesses,”
• this did not necessarily drive a shift in how markets see Fed policy conducted through YE 2023
• but then, why would stocks fall so sharply post-JH?

And even the 10-year barely moved post-JH:

• again, stocks fell sharply
• yet, bond yields barely budged
• if equities are priced off of bond valuations,
• then equities should have seen a far more muted effect

In fact, even inflation expectations fell post-JH

Similarly, market-based measures of inflation expectations fell post-JH. As shown below:

• expected inflation for the next 1, 2, 3, 4 and 5 years forward edged downwards
• the moves were pretty dramatic for 1, 2, 3 and 4 year inflation swaps
• so, if inflation expectations are down AND fed funds forecasts are barely changed
• why did equities sell off so hard?

INFLATION EXPECTATIONS: U Mich survey shows long-term expectations approaching pre-pandemic

The U Mich August final consumer survey was released Friday and long-term expectations for inflation have continued to be promising:

• 2.9% is expected 5-10 year median
• compared to 2.8% average since 2000
• 1-yr inflation still elevated at 4.8% but improving

Encouragingly, bottom 25th %-tile expectations fell to +0.6%, below the 20-year average of 1.2%

There is quite a lot of cross-sectional information in the U Mich consumer survey. Notably:

• inflation expectations for bottom 25th %-tile of responses (not income)
• fell to +0.6% the lowest reading since 2020
• below the 1.2% 20-year average
• this is significant progress

Republican respondents still see far greater inflation

But skewing consumer inflation expectations are the variances due to political affiliation:

• Republican respondents see 1-yr inflation at 6.9%
• Democratic respondents see 1-yr inflation at 3.8%
• thus, arguably, managing inflation expectations is seemingly a “political issue”
• as a side note, we believe the asset management business tends to skew Republican
• hence, markets tend to be more “hawkish” on inflation than consumers

INFLATION “HARD DATA”: PCE declining, encouraging and diffusion improving

July PCE (personal consumption expenditures) were released Friday 8/26 and the figures were generally encouraging:

• July core PCE was +0.1%, or 1.2% annualized and below +0.2% forecast
• June core PCE rose +0.6% month-over-month, a major deceleration

And as JPMorgan charts show, the decline in PCE YoY rates is becoming increasingly visible as seen below.

The trend in diffusion of components is actually improving as well. But this requires a bit of squinting.

• the chart from JPMorgan below shows in “grey” the share of components seeing >4% annualized rise in PCE
• pre-pandemic, this figure was 20%
• currently, this figure is 55%, so high

TREND: Share of PCE components >4% inflation down to 55% from 67%

Zooming in, we can see the share of components >4% inflation is actually declining:

• in early 2022
• this figure was 67%, too high
• this figure declined to 55% in July
• solid improvement
• key is seeing this figure drop to 20%

And further price cuts expected for households…

While there remain cross currents regarding inflation, the price of goods for consumers continues to see downside developments. Look at the WSJ.com article below.

• retailers of all ranges
• are seeing a glut of inventory

And this makes me wonder if the “durables binge” of consumers during the pandemic is coming to an end. Take a look at the chart from JPMorgan below:

• durables share of expenditures is now back at trend
• after a decade below trend
• but if this demand is “sated”
• prices for durables set to fall further given the piling inventory
• this impacts many “core goods” such as cars new and used, furnishings, appliances

STRATEGY: Investors skittish but we still see 2H rally… positioning still contrarian negative

The sell-off in equities on Friday was disappointing, unwinding considerable progress made by stocks over the past few weeks. But we see this pullback as an opportunity:

• Fed remains stalwart in its battle against inflation
• the Fed needs to maintain this stance to contain inflation expectations for households and businesses
• and this is the “pain” the Fed is referring to
• but in the past few months, incoming “hard” data has undershot expectations by a considerable margin
• incoming consumer measures of inflation continue to drift lower
• in fact, the bottom 25th %-tile of responses is now BELOW 20-year averages
• other leading indicators of inflation show falling inflation
• thus, we think this explains why Fed funds and 10-yr yields barely responded to Jackson Hole
• hence, we think reaction in equities was excessive

This view is also echoed by our Head of Technical Strategy, Mark Newton. As his comments:

• he think there may be near-term weakness towards S&P 500 4,000
• but this is buyable and a setup to exceed August highs
• in other words, buying this dip

And another example of negative investor positioning is below. The CFTC e-mini net non-commercial futures position:

• sharply negative to levels matching 2020 bear peaks
• markets are already positioned for negative outcomes
• therefore, risk/reward is skewed if positive developments transpire

STRATEGY: 2H rally view intact

Bottom line. We see 2H rally thesis intact.

STRATEGY: 2022 Bear market was 164 days, or 25% duration of prior bull

Our data science team put together the comparative duration of bull markets and bear markets, and the corresponding ratio:

• since 1942, there have been 14 such cycles
• median ratio of bear vs bull is 31%, meaning a bear market is roughly 1/3 duration
• since 1982, this ratio is only 15%

• in 2022, the preceding bull market was 651 days
• the current bear market was 164 (using 6/16)
• or 25% ratio

As seen below, this ratio is solidly within the ranges seen since 1982.

• many investors think “more time” is needed for this bear market
• but given the shortness of the preceding bull market 651 days versus 1,309 median
• the corresponding bear market should also be shorter

BUY THE DIP REGIME: Stocks already saw fundamental capitulation

And we want to revisit the chart below, which looks at the internals of the S&P 500 — the % stocks >20% off their highs, aka % stocks in a bear market.

• this figure surged to 73% on 6/17
• this was only exceeded 3 times in the past 30 years
• each of the 3 prior instances was the market bottom
• we think this is the 4th instance

BUY THE DIP: forward returns strong

And stocks have the best forward returns when this figure exceeds 54% as shown below:

• in 3M, 6M and 12M
• the best decile for returns
• is when this figure is oversold >54%
• hence, buy the dip regime is in force

33 GRANNY SHOTS: Updated list is below

The revised 33 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 5 of 6 portfolios
• $GOOGL $MSFT in 4 of 6 portfolios
• $AMZN $META in at least 2
• This reinforces our favorable view of FANG in 2H2022

33 Granny Shot Ideas:

Consumer Discretionary: $AMZN, $AZO, $GPC, $GRMN, $TSLA

Information Technology: $AAPL, $AMD, $AVGO, $CSCO, $KLAC, $MSFT, $NVDA, $PYPL, $QCOM

Communication Services: $GOOGL, $META

Energy: $CVX, $DVN, $XOM

Financials: $ALL, $AXP

Real Estate: $AMT, $CCI, $EXR

Health Care: $ABT, $BIIB, $ISRG, $MRNA, $REGN

Consumer Staples: $BF/B, $MNST, $PG, $PM

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33 Granny Shot Ideas: $AAPL, $GOOGL, $MSFT, $ALL, $BF/B, $CSCO, $NVDA, $PG, $PM, $ABT, $AMD, $AMT, $AMZN, $AVGO, $AXP, $AZO, $BIIB, $CCI, $CVX, $DVN, $EXR, $GPC, $GRMN, $ISRG, $KLAC, $META, $MNST, $MRNA, $PYPL, $QCOM, $REGN, $TSLA, $XOM

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