Ah, I’d love to wear a rainbow every day
And tell the world that everything’s okay
But I’ll try to carry off a little darkness on my back
‘Til things are brighter, I’m the Man In Black
-Johnny Cash
The earnings revision cutting cycle that I have been discussing has not only begun but it also continues to grind ahead. Along with this, fears of economic slowing are also increasing. These are two major factors that are creating significant headwinds for the equity markets. Hence, I am still more focused on downside risk and am still targeting 3600-3500 for my next key range and, as my key indicators continue to deteriorate, may have to introduce an even lower area as my final destination for the S&P 500.
One flagship example of how things are weakening for cyclicals is what just happened to semiconductor company Micron (MU). Last week, I released a note on GICS-L4 sub-industries to avoid and one of the areas highlighted was semi chips. Just as recently as their mid-May investor day, the company was guiding the Street to 7% above consensus on revenue and 10% above on EPS. However, this morning MU’s management negatively preannounced that August quarterly revenue would be 21% below consensus and their EPS a whopping 37% lower than the average Street estimate. This dramatic negative outlook caused large shock wave for the stocks within the entire semi chips sub-industry.
My work is flashing red lights and the sirens are loud. There have been some rumblings that pension reallocations are on deck and tens of billions of dollars are set to be shifted into the U.S. equity market as the calendar has flipped to 3Q22 and the flows could drive the S&P 500 up 5% to 7%. My work doesn’t support this conclusion and strongly suggests that any bounce that might ultimately occur will lack the drivers that would be needed to make the rally sustainable for more than a week or two.
An unfavorable fundamental backdrop as shown by widespread earnings cuts should not be underestimated. There is strong historical precedent since 1990 that the S&P 500 has been unable to post positive returns until the rate of change in the bad news reaches its maximum level, and my work says that will take at least 2-4 months.
As Micron proved this morning, fortunes can change quickly, and cyclically sensitive company and economic deceleration is occurring. With the Fed likely to remain in tightening mode until at least 4Q22, it seems unlikely that expectations can shift to re-accelerating growth any time soon. From my view, this is going to take some time and optimistic bulls who are hoping that the Fed cavalry is once again going to rescue us soon will likely be quite disappointed. Thus, I continue to urge caution. Indeed, Chair Powell’s remarks in Portugal show that central bankers are largely flying blind and, because of this fact, will likely need more sustained evidence of inflation coming down before they can even slow down the pace of tightening. From my view, easing is likely off the table for some time unless something clearly breaks that is systemically important. In my upcoming sector update that will be out next week, readers will likely see our ongoing view that investors should continue to be careful and stick to more traditionally defensive areas of the market. Beware tactical bear market rallies as they look enticing but ultimately are short-lived and fail. We would advise to NOT chase bounces right now. A buying opportunity is coming but it will take time for the risks vexing the market to play out. Wishing you all a happy 4th of July.
