Over the past week or so, a few charts have been making their way across trading desks. These are charts comparing 2022 to the 2000-2003 bear market and the GFC’s 2008 bear market. A few trading-oriented clients noted this and I found these two instances on twitter and reddit.
- the message from these charts is two fold
- first, equities rally even in the midst of a broader downturn –> bear rallies
- second, equities today have far more downside
- is it any surprise many investors expect the S&P 500 to fall towards 3,000 or so
Skeptics compare 2022 to 2000-2003 Bear Market
Skeptics compare 2022 to 2008 GFC Bear Market
In short, the recovery in stocks since mid-June has been mostly met with contempt. Contempt and skepticism because investors see multiple fundamental problems and as a consequence, equities should not be rallying:
- a recession is only getting started
- EPS downgrades are only getting started
- interest rates are still gonna “rocket higher”
- P/E needs to fall to 15X or lower
- retail investors need to be liquidated
Bascially, skeptics want to see scorched earth and no survivors. This is not our view, of course. While there remains poor visibility and considerable risks, our base case is a “growth scare” and as such, the Fed does not have to push rates as high as markets expect.
Sell-side economists are the most “hawkish” while market-based measures see Fed peaking far sooner
Take a look at this chart put together by tireless Ken and our data science team, using Bloomberg analytics. It looks at the path of Fed funds using multiple measures:
- by multiple measures, Fed is expected to be largely done raising rates in 2023
- the most “hawkish” forecasts are by sell-side economists (see 5% line)
- if the sell-side is the most “hawkish,” shouldn’t we countertrade that?
As many investors know, sell-side consensus is often too early or too late. Thus, if they see the most aggressive path of Fed hikes vs market-based measures, which one do you think is the most likely path? In our opinion, market-based measures are arguably more objective. Read as, Fed not as hawkish as sell-side expects.
INFLATION: July CPI (Wed) and U Mich Inflation (Friday) are key
This week is a big inflation week. There are multiple inflation “soft” and “hard” data points but the two most important are:
- July CPI (Wed) and headline should be weaker due to falling gasoline = good
- U Mich July inflation expectations (Fri) and hopefully this is further cooling = good
Economic Calendar per Bloomberg
CREDIT: Mild “thawing” as high-grade issuance in July is stronger than 4-year average
Credit markets have been frozen as rates soared in 2022, along with heightened recession expectations. But surprisingly, gross issuance in high-grade bonds was solid. According to data by JPMorgan:
- HG issues was up 21% versus 4-year average
- other corporate credit remains frozen
- but this is a sign of a thaw
VIX: Vix managed to fall on Friday, despite a strong labor report
And despite the many calls for a broader sell-off on the heels of a strong July jobs report, the VIX declined to new multi-month lows:
- the VIX is now ~21
- we are near the zone around April
- recall, it was April when S&P 500 fell dramatically from 4,500
- this is a notable divergence from what investors expect
POSITIONING: Investors still “light” and thus, more likely to be dragged into this rally
Our base case remains that stocks rally in 2H, after a treacherous 1H. And the path to a positive 2H is not as narrow as consensus expects:
- leading indicators of inflation are cooling, including gasoline/oil, food and supply chains
- durable goods pricing is weakening
- services prices such as airline/travel are weakening as evidenced by hopper.com
- labor markets seem strong but claims and even wage growth suggest softness
- corporate profit margins are holding up and key to supporting equities
- Fed could be moving slower in 2023 if above plays out
- if 1982 plays out, the entire bear market will be erased in months
- investors are basically in risk-off positions
On the latter point, take a look at HF net positioning on S&P 500. This is at levels similar to March 2020. This is data shared by Macro Hive and compiled from CFTC.
And as we shared last week, data from Deutsche Bank shows CTA (commodity trading advisors) exposures to equities are in the bottom 6th-percentile.
- that is serious risk-off
BOTTOM LINE: Consensus still looking for a recession and S&P 500 3,100 or lower but US tracking for a “growth scare”
Ultimately, the key divergence between our sanguine view and consensus is whether the US is tracking towards a recession (consensus) or a growth scare. In our view, recent incoming data and even 2Q2022 EPS season support a “growth scare” scenario.
- If this is a growth scare
- markets can respond positively to weaker inflation
- we expect lower inflation readings for July through December 2022
- this would give Fed greater optionality
- as Fed is at “neutral” rate today at 2.5%
- hence, equity risk premia can fall
- in 1982, the entire 36 month bear market was reversed in 4 months
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