Institutional equity investors have positioned for a recession…which means?
It is an understatement to say equities have been treacherous so far in 2022. It has been a cascade of scary developments from:
- runaway inflation fears
- Fed becoming hawkish
- WWIII risks
- “market top” calls
- “yield curve about to invert” calls
Perhaps the “darkest” report is the following headline, shared by @DougKass on twitter from another sellside firm.
- on March 4, 2022
- this firm placed 10% odds of a “civilization ending nuclear war”
- yup, 10%
To me, this is a bottom tick of market sentiment. Unless, of course, the world is hurtling towards nuclear WWIII.
But as shown below, the 3/4/2022 was contemporaneous with a general panic by the market:
- but the 2/24 lows held
- despite a cascade of negative headlines
- Fed hiked this week
- market has continued to rally
Institutional Equity investors are positioned for a recession = lots of bad news priced in
For now, this seems like a “win” — 2022 has not been easy. And Mark Newton, FSInsight’s Head of Technical Strategy, generally expects the broader equity markets to bottom around mid-2022. But as much as 1H remains “treacherous” for markets, we do not want to be a “risk-off only” 1H. This week reminds investors of the risks of being too tactical. That is, short-term risk-on and risk-off repositioning results in painful churn.
- consumer confidence has dropped so sharply
- history shows forward returns are > 15% over next 12M
- thus, we think beyond the short-term noise, the risk/reward remains excellent
Equity strategists are cutting 2022 Targets, which will prove to be appropriate if the US “breaks” into recession
We are already seeing strategists cut their 2022 outlooks. As shown below:
- 4 of 24 strategists have cut their 2022 outlooks
- these are modest cuts so far of 200 points or so
- the driver is the factors mentioned above
- but their moves will be prescient if the US “breaks” into recession
Our base case remains that the US avoids a recession. And this clarity will emerge in 2H2022. Thus, we still see S&P 500 managing to close at 5,100 or higher by YE.
Looking back at April 2020, 8 weeks into the COVID-19 pandemic, we see that 18 of 25 strategists slashed their 2020 outlooks:
- 17 of 23 cut their outlooks
- many slashed YE 2020 targets from 3,300 or so to 2,500 or worse – S&P 500 ended 2020 at 3,756
- so sellside had “over-compensated” for the downside risks
- when we see strategists call for a 10% risk of nuclear annihilation, we wonder if that is also a “bottom tick”
Latest BofA Fund Manager Survey (FMS) shows institutional buyside is positioned for a recession
Similarly, the latest BofA FMS shows the buyside is positioned for a recession. Take a look at two highlights below:
- cash balance is now nearly 6%
- matches April 2020
- as annotated below
- this is “peak” positioning in a recession
Two takeaways:
- if the US does not “break” into recession, this is a contrarian signal
- lots of “bad news” is baked in
Pessimism is similarly high. The “% respondents expecting a stronger economy” has collapsed
- it matches the pessimism of October 2008
- Oct 2008 was still 6 months before major bottom
- but many sectors had bottomed in Oct 2008
Thus, two takeaways:
- if markets “break” into recession, the buyside is positioned for this
- lots of “bad news” is baked in and arguably much more than warranted
This is another sign that the institutional world is positioned for a recession. Could a recession happen? Of course. But that is not our base case and we expect the US to manage to avoid a recession.
STRATEGY: Fed “put” arguably closer to a 10% drawdown in stocks today…
Fortunately, oil is taking a breather. After soaring to nearly $140 per barrel, oil has settled in just below $100. And the surge in the past month, as many know, is due to economic sanctions imposed by the US and western policymakers after the Russia-Ukraine invasion.
- And as we noted, this surge in commodities is essentially a massive fiscal tightening, driven by govt policy
- amplified on top of this is the 10% decline in stocks, which is amplified by the PEP effect, forced selling by oligarchs
But on the topic of oil, we can see that in the past decade, $100 oil was fairly common. This flies in the face of the pundits who say $100 oil is going to “break the economy” into recession.
- between 2010 to 2014, oil was routinely $100
- I don’t recall calls for calamity due to this
…data by tireless Ken shows on a “cost per barrel-basis” oil is cheaper than Diet Coke or Orange Juice
Oil takes 100 million years to make. First, it starts off as organic matter, then turns to coal and after millions of years, becomes oil. While many ESG-minded folks wish to see oil use end (which it will), oil is widely used today. But the difference is now that oil is also becoming part of a national security issue. Russia-Ukraine war is reminding us of this.
- oil is $100 per barrel
- Diet Coke, at $1.33 per two liter bottle, works out to $157 per barrel
- Even bottled water is more expensive than oil at $331
So why do we think $100, even $200 per barrel is the peak for oil?
…But the fall in equity prices and surge in oil are hurting consumer sentiment.
As noted Monday, the latest University of Michigan Consumer Confidence survey shows an utter collapse of sentiment. Present condition is down to 59.7 which was only seen 2X in the past 40 years:
- 1980s around last Energy crisis
- 2008 GFC
So, consumers see today as bad as stagflation and the Great Recession. Does this make sense? I don’t know but I find this puzzling. In fact, I think this has a lot to do with not only oil but also the drop in stock prices.
…Bottom decile confidence = extraordinary upside for equities 12-months later
As for implications for stocks. At the extremes, consumer confidence is a contrarian indicator. Below are the deciles of consumer confidence and the corresponding forward return of equities:
- at bottom decile
- S&P 500 forward returns average 15%
- this is the single best time to own equities
See the point? While pundits are bearish and say the US economy will “break into recession” due to war + inflation and while consumer confidence is basically at the worst readings in 40 years — this is the time to counter trade consensus. By the way, the Feb 24 lows have held, which we also think is somewhat encouraging.
FED PUT: We think it is at much higher levels than the markets appreciate
The FOMC meeting was held Wednesday and Powell raised rates by 25-bps as expected. Historically, markets have rallied after the first hike and we see this is a useful piece of information to pay attention to.
- and as our Head of Technical Strategy, Mark Newton, notes
- Markets typically rally after the first hike
- so this will be the “rip the bandaid” moment
…Consensus sees Fed “put” below S&P 500 3,750 but we believe it is far higher
You might recall this chart from a February 2022 Bank of America Fund Manager Survey. It shows that consensus believes the Fed “put” is at S&P 500 below 3,750.
- this is about 15% below current levels
- we believe the Fed “put” is higher
We will explain below, but it has to do with the impact of a 10% drop in equity prices and its associated impact on consumer net worth.
Household ownership of equities is $45 trillion, or 188% of GDP = greater exposure to equity and drawdowns
The obvious reason is stock holding by households are now $45 trillion or 188% of GDP. This is the highest level ever and above the 100% levels seen during the GFC.
- think about that
- if equities are 2X the relative size to GDP
- a 10% drop in stocks has a far greater impact than in the past
…a 10% drop in equity prices is now a “net worth” hit of close to 20%, far higher than the past
It is for this reason we see the Fed put coming in at a higher level:
- a 10% drop in equity value for households today = 18% drop in net worth as % GDP
- this is far higher than in the past
- in fact, as the red dot shows, the Fed rate cuts happened with a 10% hit to HH net worth was far smaller to GDP
- the connection between “household net worth” to GDP is the wealth effect
- a portion of the change in net worth is spent (if there are equity gains) or reduced (if equities fall)
- thus, with stocks more than 10% off their recent highs
- US household net worth has fallen by $4.5 trillion
- that is a huge hit
- and the wealth effect implications are substantial
In other words, consumer spending will take a hit due to:
- higher gasoline
- extra soaring commodities (due to economic sanctions now)
- 10% drop in stock prices wiping out $4.5 trillion of net worth
Yet, somehow doesn’t it seem like an aggressive Fed hike program is not congruent with the above? That is why we think the Fed “put” is at higher levels than institutional investors believe.
Figure: Themes in 2022 – “BEEF”
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
