What Our Clients Are Talking About Behind The Scenes

FLASH COMMENTS:

Last week, I did my deep dive into my single stock quantitative selection model that I call ERM and was looking quite closely at the earnings revisions of nearly 4000 U.S. companies.  So, I had fewer client calls then normal and spent a bit less time looking at the day-to-day wiggles in the market.   

The market continues to bounce around with nearly every piece of macro news between recession, inflation, more Fed/less Fed, and crude up/crude down to name just a few things that impacted recent trading.  My work continues to be quite clear, and I suggest stop watching every data point looking for a sliver of bullish news to support an optimistic outlook.  Yes, I know being a bear isn’t popular and we all have to be on alert because there is quite often a bull market in something.  And yes, there will be a time to start becoming more constructive again, but my work says that point is still on the horizon. 

In my view and based on my key indicators, the Fed is going to keep tightening until there is a clear 3-5 month trend that inflation is down and that the labor market is weakening.  Last week’s data release of the monthly employment report did not support the view of the immediate collapse of the U.S economy and major deterioration in the labor market, which Fed officials have commented is one of the metrics they are watching closely and are trying to weaken a strong jobs backdrop.  It’s hard to bet that this is not going to happen, and YES, at some point, the FOMC will slow the pace of tightening and then will likely evolve to data dependent, but this needs some time to play out and there is still a huge gap between pivoting to going back to an outright easing policy stance.  Granted, a Ukraine/Russia peace deal or anything that lowers energy pricing from the supply side, or something breaking that causes the Fed to change its focus. 

A major question that I continue to struggle with is timing — does the inflation coming back down, economic slowing, estimate cuts, and price discounting mechanism occur slowly over several quarters or quickly before we reach 4Q22?  Regardless of which timing outcome, my analysis continues to show that we have not reached maximum pessimism yet and stock prices/valuation levels have not fallen enough to signal that investors have fully discounted everything. 

When specifically looking at just my earnings revisions work, it continues to weaken and still has plenty of room to fall further to near historical negative extremes, which lead to contrarian bullish readings.  Hence, I am retaining my ongoing bearish stance and am targeting 3600-3500 as my next downside target.  Importantly, please note that I am also moving closer to introducing a lower downside range but am still looking for a bit more evidence.  Nevertheless, the probabilities are increasing that I will have to move my bearish S&P 500 forecast zone even lower within the next month.  As a result, I am still advising that investors should look to sell rallies and increase hedges as volatility remains muted on the bounce attempt. 

For investors that need to be invested and need to focus on relative performance, my work continues to show 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 my expected downward estimate cuts over the next 3-6 months.  I have recently updated my sector weightings ( Report Link ) that reflect this view as most of the above benchmark exposure is a mix of traditional defensive and offensive growth.  For cyclicals, my work strongly suggests that one should focus on single stocks to outperform other cyclicals for your exposure rather than broad based overweighting.  The names that my work is flagging are mostly higher quality as poor operators and management teams are having a harder time reaching their profit forecasts and will likely not be handed any get out of jail free cards in the form of new stimulus for quite some time. 

Bottom line:  Remain careful and alert for a possible pivot if a sudden Ukraine/Russia peace deal starts to surface.  Despite the possibility of additional oversold tactical bounces that will occur from time to time, my key indicators are still weakening and nowhere near negative extremes, which suggests considerable downside risk remains.

MAIN CLIENT ISSUES

• Confusion, Frustration, and Lack of Firm Views
• What’s priced in?  Fed?  Earnings? 
• Growth versus Value positioning

SPECIFIC CLIENT QUESTIONS

• Key takeaways from monthly deep dive at the individual stock level? 
• What looked the most interesting on the long side?
• Any single names that caught your attention?

MY ANSWERS

• Key takeaways from monthly deep dive at the individual stock level ?

Last month, when I described the health of estimate revisions, I stated that things were — U-G-L-Y.  For me, I meant that the number of stocks with negative sloped ASM indicators was broad based.  Yet, the rollovers had not yet fallen below zero which would signal a shift from “less good” to absolute cutting, and that the red bars that show the magnitude of estimates being lowered were not widespread.  Based on my analysis, this is a strong piece of evidence that there has been a clear deceleration of positive revisions, but the cutting cycle that I have been expecting is still in the early stages. 

After completing my deep dive last week, the data shows unequivocally that profit forecasts are being reduced, but activity thus far has been quite modest for most areas/names.  When looking at historical cycles over the past 30 years, there is still a long way to go before max pessimism is reached.  Why is this important?  Since 1990, a prerequisite for the equity market to put in a sustainable investment bottom (i.e. THE BOTTOM) is the ASM indicator for the overall market reaching a negative extreme and positively inflecting that would signal that the rate of change in the bad news is improving.   

Based on my analysis of these cycles, I have concluded that the analyst lowering is a process that normally takes around 2-4 months, at minimum, and the current readings still need more damage before it flashes its normal contrarian favorable signal. 

Bottom line:  My work is quite clear that the “E” is important and is in fact critical.  In addition, it shows that my expected estimate revisions cutting cycle has clearly started but is still in the early innings.  Historically, this takes time to play out.  Granted, the amount of time can vary depending on many factors, but there is little precedent to expect it to be less than 2-4 more months.  And I would be remiss if I didn’t state that it could take longer.  I will likely remain cautious until the rate of change reaches its most negative point barring a sudden shift in the oil/Fed situation. 

• What looked the most interesting on the long side ?

Aerospace & Defense, Environmental & Facilities, Casinos, Pizza, Dollar Stores, Brewers, Distillers & Vintners, Beverages, Tobacco, HMOs, Large Cap Biotech, Pharma, signs of life in Software. 

• Any single names that caught your attention?

Contrarian Favorable (FOR RELATIVE PERFORMANCE)

ROL -0.66% , FDX -0.67% , DPZ -0.26% , MCD -0.19% , SBUX 0.40% , AMZN -1.39% , AMGN 0.18% , BIIB -1.55% , INCY 0.20% , LW -0.43% , ZTS

In-Motion Favorable (FOR RELATIVE PERFORMANCE)

CVX -0.02% , NOC 0.07% , CI 1.30% , HUM 0.00% , KO -0.04% , MNST -0.49% , PEP 0.22% , CPB -0.69% , GIS -0.50%