What Our Clients Are Talking About Behind The Scenes

Over the past week, the S&P 500 has ground up once again and has continued making new all-time highs even as the Wall Street forecasting crowd continues to shift towards worry.  Institutional investors have been negatively impacted by this growing anxiety and have either shifted away from Value/Cyclicals or have paused their rotations to reevaluate.  The main issue has shifted towards the expected deceleration in economic growth that is likely to occur in the coming quarters.  My work agrees that it is nearly assured that growth will decelerate as the recovery continues, but my work does NOT support the view that investors should be shifting away from my preferred positioning of Value/Cyclicals.  With that being said, there could be small selloffs along the way.  Importantly, however, my research remains resolute that there is still upside potential for the overall equity market and that my recommended themes are still intact.  Consequently, I continue to view price moves that are contrary to my medium-term views as opportunities. 

I continue to remind subscribers that when one does not have a disciplined process to depend on, they may be overly influenced or more inclined to make emotional decisions based on the headline news or tactical market action.  At FSI, we use disciplined, objective, and data driven approaches that form the foundation for our research and idea generation to help our subscribers stay grounded and properly positioned to take advantage of the dominant trend.  

With that being said, this week’s comments are below, which include the questions and issues that were brought up the most often in my institutional client meetings, and I will then follow with my responses.

ISSUES

• As has been the case for several weeks, my calls continue to be dominated by macro discussions. 

• Clearly, rising interest rates is not currently at the top of investors worry list.  This has been replaced by the potential for peak rates of change in GDP and ISMs. 

• The week began like the last several with investors somewhat confused and seeking clarity and updates on my longstanding constructive views on the overall equity market and Value/Cyclicals/Recovery/Reflation. 

• The end of week shifted towards Biden administration tax proposals and several competitors turning towards neutral to outright bearish. 

• Through Thursday’s close, there were lots of questions about the weakness this past week in Financials, Technology, and Energy. 

SPECIFIC QUESTIONS

MY ANSWERS

• Several Wall Street firms have tempered their bullishness quite a bit as they are pointing towards the rate of change on growth peaking and that it will start decelerating.  What are your thoughts about rotating away from Value/Cyclicals/Reflation because of this?

In my view, this is probably one of the most important points from this past week and will likely linger for a while.  Therefore, I think it needs some explaining. 

YES, growth measured by either GDP or ISMs will likely hit their respective peak levels during 1H21.  Notably, however, we strongly DISAGREE that this expected roll over in these metrics should be used to rotate away from Value/Cyclicals/Reflation. 

Yes, historically these types of decelerations have led to rotations away from Value/Cyclicals/Reflation.  So, why do I hold the view that investors should not only keep the same positioning, but should look to get even BIGGER? 

I always remind investors that knowing the macro playbook is great, but I also warn to not just react to a line inflecting and start making definitive investment conclusions.  One has to fully understand WHY the relationships worked in the past.  In this case, I ask the following questions:

• What was happening in the past when GDP and ISMs were reaching peak levels and rolling over? 

My research and historical work show that these metrics had been rising strongly and were getting late in their respective cycles, which had led to the Fed shifting to a tighter policy stance and interest rates were rising.  Thus, the rollover in the growth and activity metrics were showing the lagged impacts of the tightening that had occurred AND the continued tightening that was still going to come in the future.  So, the negative inflection was indeed signaling that the cycle was ending and that a rotation towards defensive growth and higher quality was warranted. 

• Is this in place now?  Is GDP growth and ISM peaking as a result of Fed policy and rising rates?

In my view, definitely NO.  Hence, could the macro playbook be wrong this time?  My work suggests a high conviction YES.  The upcoming decelerations are merely the result of abnormally high levels of growth that will be reached as result of coming off low bases that will occur because of the forced economic lockdowns during 2020.  Based on my work, they are NOT signaling that the cycle is over and that we are heading on the path back to recession.  More likely, these metrics will normalize back to levels that were present pre-COVID. 

• Is there a difference in the earnings revisions behavior in these two scenarios?

YES, big differences.  In the historically normal scenario, my earning revisions work begins flashing important warning signals for offense, cyclicality, and the leadership at that time.  What does this mean?  The Analyst Sentiment Measure indicators (ASMs) for a growing number of names begin to rollover from extreme positive readings, which I sometimes call falling from an upper right hand corner level.  This is what has normally caused me to start rotating away from these types of names, which was the case in February 2000 and December 2007/January 2008. 

Now, in the scenario I am expecting for 2021, an unusual but not unprecedented situation should occur with the earnings revisions.  Despite the high likelihood that GDP and ISMs will rollover, the earnings revisions are likely to STRENGTHEN for Value/Cyclicals/Reflation.  Why would this happen?  It is my view that the analyst community has not broadly begun to raise their profit forecasts for the out quarters (3Q21 and 4Q21).  From my perspective, this is not fully understood by investors, and bearish forecasters are not considering this important fact.  If this plays out as my work strongly suggests it will, this is clearly NOT the time to rotate away from Value/Cyclicals/Reflation. 

Based on my research, this is a critical point.  More on this in coming weeks. Stay the course and buy any recent relative weakness in Value/Cyclicals/Reflation. 

In my view, the early reports were overall in line with my expectations, which continues to be for robust results that will likely exceed the current consensus expectation for 1Q21 S&P 500 yr/yr growth of nearly 22% by 5-8%.  I reiterate my view that Corporate America has done an impressive job of  improving their cost structures that will create significant operating leverage.  Although, there may be a handful of high-profile misses or overly conservative guidance, our research is still pointing to final results that will be quite good and help provide fuel for equity markets to keep moving higher. 

• What stands out the most for the overall equity market from your earnings revisions based ERM model? 

The continuation of broad-based strength in the U.S., especially within Value/Cyclicals/Reflation/Recovery and SMid.  Not surprisingly, the traditionally defensive areas of the market — HC, Staples, Utilities, Real Estate, and legacy Telecomm — are showing clear relative weakness, which continues to underpin our underweight recommendations.  There is close to zero evidence at this point based on my earnings work to abandon our longstanding key themes that we have been discussing. 

• More specifically, from a sector/sub-industry basis, are you seeing anything worrying in your earnings revisions work for SMid or the Recovery trade?

First, the big take away is my work remains quite favorable; that is neither extreme nor showing signs of second derivative weakening. 

Second, many of the same areas that I have been highlighting and recommending still look like there is more to come:

Energy (Equip, E&P), Materials (Chemicals, Packaging, Industrials Metals, Construction Materials), Industrials (Building Products, Capital Goods/Machinery, Transports), CD (Auto & related, Vacation/Travel/Internet Booking, Retailers/Restaurants), Financials (Banks, Invest Banks/Brokers/Asset Managers), HC (Equipment/HMOs), Real Estate (Office/Retail/Hotel). 

• How does Tech look like both absolute and relative in your work?

From both an absolute and relative basis, the overall sector still looks constructive.  Hence, I want to remind investors that despite my work favoring Value/Cyclicals/Reflation/Recovery and SMid that I have not and still am not recommending that they should abandon Growth/FAAMG.  I reiterate that my work suggests that investors just need to be mindful of their weightings and that the overall sector is likely to lag our preferred positioning of Value/Cyclicals/Reflation/Recovery and SMid, but should outperform the market, defense and cash. 

Importantly, my earnings indicators still show that the ASMs for ALL the major Tech stocks still look favorable on an absolute basis.  Therefore, they are not shorts, nor should they be sold down to zero, but relatively they look less attractive.  On an intra-sector basis, the ERM continues to favor cyclical industries — Semi Equip, Semis, Data Processing (MA/V), Hardware (STX/WDC), and names related to the manufacturing chain (Electronic Instruments, EMS, Tech Distributors).

• Your tactical indicators have been mainly favorable since their tactical bullish signals from both early March and during the last week in March.  Are they extreme yet and have they rolled over?

NO and NO.  As I have commented, my key aggressive tactical indicators — HALO, HALO-2, and V-squared (see explanations at the end of the note) — are still all favorable and NOT extreme.  With that being said, we continue to remain alert for a short-term be careful signal. 

Bottom line:  As angst continues to growth within the Street, the U.S. equity market continues to climb the “Wall of Worry”, and my research strongly suggests that investors STAY THE COURSE.  As I have been discussing for many weeks, my main themes of higher markets, Value/Cyclicals over Growth/FAANG, and SMid over large are still intact based on the key indicators in my investment process.  I would also reiterate that there remains the likelihood that there may be some volatility and headline risk over the next couple of weeks as the reporting for Corporate America’s 1Q21 profit announcements start to increase.  Notably, there is no change to my outlook and recommendation to use relative weakness in the sectors/stocks that my work continues to flag as favorable as opportunities and avoid the areas that have unfavorable indicators. 

There is no change in view that as we keep moving into the Spring/Summer and the increasing likelihood that the broad country-wide vaccination deployment reaches key thresholds that the odds of moving towards the national reopening of the U.S. economy rise each day.  This will shift the recovery to another level that should continue producing tailwinds for the ongoing equity market rally.  It’s a time for investors to stay disciplined and keep an eye on where things are going and not the day-to-day wiggles so one can take advantage of a favorable backdrop for equities. 

Definitions of HALO, HALO-2, and V-squared

HALO = The proprietary Fundstrat Portfolio Strategy Halo Model is a multi-factor model that attempts to predict the forward 1 – 6 month relative performance of a group.  The goal is to help both strategic accounts better time their implementation strategies that would be consistent with our more strategic conclusions derived by our sector/sub-industry 8-panels as well as our stock specific Estimate Revisions Model (ERM), and to generate tactical ideas for aggressive trading accounts. 

HALO-2 = The proprietary Fundstrat Portfolio Strategy HALO-2 Model is the raw tactical data behind our standard HALO multi-factor model described on the previous page.  It is useful for identifying aggressive tactical trading bottoms for the S&P 500.   

V-squared = The proprietary Fundstrat Portfolio Strategy V-squared indicator at its lowest level shows the ratio of VXV (the 3-month CBOE S&P 500 Volatility Index) and the VIX (the 1-month CBOE S&P 500 Volatility Index).  This tool is also useful for identifying aggressive tactical trading bottoms for the S&P 500.