Big data week ahead (JOLTS/FOMC) but bias positive as inflation discussion now more "two-sided" and stocks are not doing what consensus expects.

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Stocks are not doing what consensus expects… consensus might be wrong, not price

The reasons for stocks to continue falling are well known, among them:

• inflation too high
• Fed going to keep pressure on markets
• Europe entering a recession
• China zero COVID lockdown continues
• Earnings are slowing
• Stock charts look like 2008 and many pundits say 2022 will be worse than 2008
• Russia-Ukraine war will linger for years

Last week, there were plenty of reasons for stocks to sell off hard:

• market stalwarts like GOOG 0.29%  AMZN 0.82%  META 2.35%  disappointed and sold off double-digits
• September PCE, Fed’s preferred inflation measure, came in at 5.15%, up from 4.89% in August
• China instituted further lockdowns

Yet, the S&P 500 managed to gain 4% for the week, bringing total gains to 12% in two weeks. The most interesting takeaway, in our view, is that consensus has become even more negative in the face of the market gains.

This tweet by @lloydblankfein, former CEO of GS 1.30%  Goldman Sachs, summed it well. EVERYONE is negative. But some things could go right.

And this tweet below is pretty typical of our conversations with institutional investors. Investors remain negative as they expect the Fed to quash any market rally.

• this, of course, is a possibility
• but the key is whether inflation could improve faster than consensus expects
• that remains our view

NOVEMBER: Equities particularly strong when retail sentiment negative…

It is obvious to state that retail investor sentiment is negative. We have highlighted in multiple recent reports that AAII retail sentiment has posted the longest stream of negative sentiment ever. And since 1987, this has been a contrarian positive sign.

Our data science team, led by tireless Ken, looked at equity performance into YE when sentiment is negative. The results are interesting:

• since 1987, equities have a positive bias into YE (see black line)
• but when taking the bottom decile of readings, ex-2008 (which is GFC)
• equities do particularly well with average gain of 7%
• and as chart below highlights, pretty much a straight line up
• the takeaway is there is a positive sentiment factor at work (bearish sentiment is bullish) along with normal market seasonality

And market internals are slowly improving. Take a look at the chart below and pay particular attention to the green line:

• on up days, the % stocks rising is 90%
• levels not seen since 2020
• while the downside participation of stocks is falling
• this is far different than June-August 2022

WEEK AHEAD: Big data week, JOLTS and FOMC most important

This coming week is a big week for incoming macroeconomic data. Take a look below. The keys, in our view, are:

• September JOLTS (job openings) on 11/1
• FOMC rate decision on 11/2
• but also important
• ISMs for October
• Employment report for October

At this point, few should believe the US economy is “accelerating” or getting stronger. And the key is to see the labor markets soften, as this remains the Fed’s largest concern. Tight labor markets create the risk of a wage-price spiral.

• if we were to hazard a guess
• this will be a week where “bad news is good news” as signs of economic slowing support the idea of a Fed pausing after December 2022
• JOLTS hopefully falls below consensus of 9.625 million

The Fed is putting particular weight on JOLTS (Job openings) report, as they view this as the best measure of the unusually tight jobs market. And JOLTS openings have gone parabolic in the last year. And as referenced by the Fed report (St Louis/NYFRB), the majority of the rise in openings has been “poachings” from other employers and thus, weakening in JOLTS could create a soft landing for the economy.

Linkup forecasts September JOLTS to ease 2% to 9.8 million which is above current consensus of 9.625 million. But we don’t think either print will be necessarily a negative.

• rather, a good outcome would be JOLTS below 9.625 million (positive surprise)

FOMC: +75bp baked in for November, but pace forward is market focus

The Fed decision on Wed (11/2) is what consensus sees as most market moving (stocks have moved more on CPI days than FOMC days). But this is obviously important.

• Street is expecting +75bp, which as Goldman Sachs economists note, is because this is what is “baked in”
• but after November, the pace of future hikes is what markets will be looking for
• Street seems to be expecting 50bp in December and the likelihood of some type of pause
• suffice it to say, markets will be watching this report closely

Increasingly, economists expect the hiking cycle to be nearing an end. As highlighted by JPMorgan’s economics team below, they believe the “most synchronized and aggressive hiking cycle in 40 years will end by early next year.” Naturally, we expect many investors to be skeptical as many see inflation as inherently unpredictable. But keep in mind, this is rhetoric we did not see in mid-2022. So, this is a change in views.

And one of the more durable positives is the growth in US wages seems to be cooling. Even 3Q2022 ECI (employment cost index) came in at 1.2% which is below the 1.3%/1.4% figures for 2Q2022/1Q2022. So, on the margin, wage pressures are improving modestly, and in the right direction.

…one perspective to appreciate, markets starting to see incoming data as more “two sided’

This takes us back to this notion that markets can shift from seeing things from “half-empty” to “half-full” even if the cadence of the data is the same. This simple illustration below makes our point. The two colors highlighted in the red boxes are actually the same color. But can be viewed as either bullish or bearish, depending on one’s perspective.

• the point being
• incoming data is no longer viewed as only “bad and justifies a selloff”
• inflation has become a more two-sided discussion
• weak incoming data the same way
• Fed has more breathing room as rates are nearing levels the Fed sees as tight
• while inflationary pressures, still high, are set to cool given multiple leading indicators
• we still believe when the “hard” data and “soft” data sync, this will be a drop in inflation

TAKEN TOGETHER: Stocks should see a better rally than the 23 trading days/ +16% seen in July

So this takes us back to this chart. The last real rally in stocks was the July to August rally:

• rally was 23 trading days and +16%
• driven by a belief that inflation was potentially peaking and Fed would pivot
• instead, services inflation accelerated and Fed talked down pivot talk
• but the backdrop for a rally now is more favorable
• inflation is now a two-sided discussion and pressures on labor, housing and services all show cooling
• Fed, Bank of Canada, ECB, RBA have all made somewhat dovish comments, contrasting with summer 2022
• investors are far more risk-off compared to anytime in 2022
• the % stocks participating on upside is 92%, far higher than anytime since 2020, well above June-Aug 2022 levels (see above)
• hence, we expect stocks to rally more strongly than the July-Aug gains
• something closer to 30-50 trading days and a gain of 20% to 25%

REAL RETURN: If S&P 500 rallies back to 4,400…Fed still wins as real returns -16%

This gets us to the notion of a rally in equities. While many cite Fed as pushing back on stocks recovering. Take a look below:

• S&P 500 is down -30%-ish in real terms (adjusted for inflation)
• If S&P 500 rallies to 4,400 to 4,600 in the near term
• This is still down -12% to -16% in real terms
• That is a dramatic wealth effect loss and tightening of financial conditions

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