FAANG default risk (CDS) less US govt = more reason to OW (even now). Regional banks see DeMark "13" buy setup = stick along with OW "temporary Fed put"

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Tune into our webinar “Super Granny” Shots next week 5/23 (Tuesday) at 2pm

• we discuss “Super Granny” shots that expected to tactically gain near-term
• and “Sleeping grannies” which we expect to tactically underperform

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The S&P 500 remains stuck in a narrow 4,100-4,150 range, something seen for the past few weeks. The primary issue currently, in our view (and only our opinion) is the debt ceiling risk (“x” date could be as early as June 1) creates a binary outcome for markets, which is difficult to equilibrium price an outcome. Hence, stocks are struggling within a narrow range, fighting a “game of inches.” This has been a light macro week, so no tie-breaker data is emerging. But we have some key observations:

• Markets are beginning to fade the “inflation” trade. The most notable is Paul Tudor Jones, a legendary macro investor, on CNBC Monday suggested “Fed is done raising rates” — the first major macro investor, we believe, to have shifted to a more constructive view on inflation/rates. JPMorgan’s Nikos Panigirtzoglou similarly discussed “inflation trade retrenches further.” The 1-yr inflation breakevens now sit at 1.87%, the lowest since pre-pandemic days. In other words, markets are starting to price out inflation risk.
• Home Depot HD 2.18%  on their earnings call also noted consumer spending patterns (bigger ticket) have softened, prompting the company to lower guidance. This is arguably strengthening the case for an extended pause. A slowdown by the consumer is an abating of inflationary pressures.
• The debt ceiling risk, on the other hand, is moving to the forefront. After the close 5/16, Congress held a press conference it looks like both sides are hopeful a deal is near held and as Sen Chuck Schumer noted, discussions have been “respectful” — while this is a binary risk, this is ultimately a positive catalyst if default is avoided. In the meantime, how can markets properly price such “event risk”? Sort of impossible because of two possible outcomes (even if a deal is highly probable). Thus, this contributes to the S&P 500 being stuck in range. A “game of inches” (See below).
• Currently, US Govt 5-yr CDS (credit default swaps) has a spread of 67bp, which implies an expected default rates of 5.9% (using Bloombergs CDSW ). As the chart below highlights, this puts US default risk closer to EM nations like China, Brazil, Mexico, Italy whereas developed nations have CDS spreads of 13-30bp. Is it any wonder that US equity investors are fearful.
• FAANG more “creditworthy” than USA: US default risk perceptions so high that FAANG have lower CDS spreads.
  – Apple (AAPL 5.94% ) 5-yr CDS is 27bp,
  – Alphabet (GOOG 0.29% ) 41bp,
  – Microsoft (MSFT 2.28% ) 45bp,
  – Amazon (AMZN 0.82% ) 47bp,
  – AMD (AMD 2.97% ) 56bp,
  – even Netflix (NFLX 2.52% ) 78bp
• Doesn’t this strengthen the case to be long FAANG? That remains our favorite sector in 2023.

STRATEGY: expecting an upside resolution towards S&P 500 4,200-plus but binary risk on “debt ceiling”

The fact is a binary event is weighing on market risk-appetite, at a time when there is little incoming macro data. Thus, markets are stuck in the near-term. That said, we see the rationale for being OW the following:

• FAANG—Seen as safer than US Govt = TINA: Isn’t it remarkable that FAANG have lower perceived default risk than US govt? This is another reason we view a sort TINA (there is no alternative) with FAANG. By the way, 1Q23 revs growth was positive for 7 of 9 FAANG (highest NVDA 3.42%  +46%) and recall R&D spend is substantial as much as 32% for META 2.35% . Thus, these are companies with:
  – solid revs growth in 2023
  – continued value capture via R&D
  – reasonable valuations considered less risky than USA
• REGIONAL BANKS—Newton sees upside on DeMark “13” Buy signal: Mark Newton, Head of Technical Strategy, noted that Regional Banks (KRE 1.35%  ETF) registered a “13” buy setup both for daily and weekly timeframes. This is positive tactically. And we are sticking with our tactical OW on the notion of “temporary Fed put” on regional banks. The 5 names we highlighted are: NYCB 4.15%  EWBC 1.87%  WAL BANC 2.88%  CNOB 2.36%
• Industrials XLI 0.70% : No catalysts near-term, but we see bottoming of PMIs as rationale to OW XLI 0.70% .
• S&P 500 P/E 14.8X ex-FAANG—REASONABLE: We simply do not see equities as that expensive, especially with Fed on a “pause.” Ex-FAANG, the forward P/E is 14.8X and the most expensive stocks are Staples (~20X) and Utilities (17X).

Markets are a game of inches as the debt ceiling debate is holding markets back.

USA is priced like an emerging market in CDS world…

Currently, US Govt 5-yr CDS (credit default swaps) has a spread of 67bp, which implies an expected default rates of 5.9% (using Bloombergs CDSW ). As the chart below highlights:

• US perceived default risk prices it closer to EM nations
• China, Brazil, Mexico, Italy all have CDS spreads around where the US is currently prices
• whereas developed nations have CDS spreads of 13-30bp.
• this is purely due to the upcoming debt ceiling limit and fears an expansion cannot be reached

As we noted above, is it any wonder that US equity investors are fearful?

Fortunately, a deal could be coming together. As the press conference today highlighted, it seems like discussions have been respectful.

FAANG more creditworthy than US government currently
Where can investors find relatively stronger credits? Believe it or not, FAANG is one place to find stronger balance sheets and perceived creditworthiness.

• US default risk perceptions so high that FAANG have lower CDS spreads.
  – Apple (AAPL 5.94% ) 5-yr CDS is 27bp,
  – Alphabet (GOOG 0.29% ) 41bp,
  – Microsoft (MSFT 2.28% ) 45bp,
  – Amazon (AMZN 0.82% ) 47bp,
  – AMD (AMD 2.97% ) 56bp,
  – even Netflix (NFLX 2.52% ) 78bp
• Doesn’t this strengthen the case to be long FAANG? That remains our favorite sector in 2023.

And this really surprised us this past week. Paul Tudor Jones, a legendary macro investor, on CNBC Monday suggested “Fed is done raising rates:”

• he is the first major macro investor, we believe, to have shifted to a more constructive view on inflation/rates.
• he also noted he expects stocks to “finish the year higher from here”
• granted, in his interview, he also noted that higher rates are like “chemo” and thus, a recession is on the horizon.
• But the key is he believes the Fed is done raising rates, and this means the inflation trade should be fading.

JPMorgan’s Nikos Panigirtzoglou similarly discussed “inflation trade retrenches further.” He highlights how this is playing out in many markets, but this means stocks could start to shed the “inflation risk premia” hurting valuations.

The 1-yr inflation breakevens now sit at 1.87%, the lowest since pre-pandemic days. In other words, markets are starting to price out inflation risk.

FAANG: Still growing nicely

There are many who see FAANG stocks as ex-growth. But that is not necessarily the case.

• 1Q23 revs growth was positive for 7 of 9 FAANG (highest NDVA +46%) and even full year 2023 are impressive figures.
• 3 companies are projected to be down YoY for the full year: AAPL 5.94%  AMD 2.97%  GOOG 0.29%
• but each of these has their own catalyst as well.

R&D spend is also a driver of future shareholder return. So a high figure, in our view, reflects the innovation intensity of these companies.

• top of the list is 32% for META 2.35% .
• but these figures are really high for all, and even TSLA 0.64%  at 3%
• is above the 1.5% for SPY 1.36%  S&P 500 overall.

REGIONAL BANKS: Newton sees favorable technical setup

On 5/7, we added regional banks as a tactical buy as we saw a temporary “fed put” on the regional banks. Since then:

• regional banks have been under some pressure underperfoming S&P 500 by -300bp
• but we see this as still an attractive risk/reward and markets are differentiating banks too
• NYCB 4.15%  EWBC 1.87%  WAL are outperforming
• moreover, the technical setup has improved according to Mark Newton, Head of Technical Strategy
• Newton notes a “13” buy setup in the daily and weekly for KRE 1.35% .

Below is the daily DeMark of KRE 1.35%  and we highlighted the “13” buy setups:

• On 5/2, the TD sequential count registered a “13” buy
• On 5/4, the TD combo (v1b) registered a “13” buy
• and as Newton notes, there has been a “price flip” higher
• the count has turned positive for both combo and sequential
• this suggests further gains ahead for the regional bank trade.

VALUATION: S&P 500 not as expensive as many argue

Lastly, keep in mind S&P 500 P/E is 14.8X ex-FAANG.

• most expensive groups are defensives
• Staples ~20x and Utilities 17x
• Energy and Financials are 10X-12X
• Media/telcos 9.9X

US VS CONSENSUS VIEW: Last week’s data positive for forward returns, but still huge gap vs consensus

Below is a stylized graphic illustrating the difference between our constructive view on equity markets (still see ~4,750 by YE 2023) versus the persistently negative views held by the vast majority of our institutional investor clients:

• this is designed to show that despite relatively encouraging incoming data, there is still a sizable gap between our constructive view and the bearish consensus view (Fundstrat client consensus).
• As warranted, we will update the below chart but as it stands:
  – we see +14% upsideto equities in the next 12 months
  – many clients believe we will “re-test” the lows, which implies -15% downside
• The reasons for the yawing gap are multiple, but we highlight a few on the graphic below:
  – Debt ceiling risks are “binary” and impossible to normalize
  – fears regional bank contagion widens to a financial crisis
  – growing office vacancies threaten a CRE meltdown
  – EPS risks substantial given Fed tightening + regional banks
  – inflation remains sticky via prices and via wages
  – Fed is only “paused” and could easily start raising again
  – Russia-Ukraine war could easily become a larger conflict
• We have written extensively our counterpoints to the above, but the ultimate issue is that:
  – we believe inflation will prove to be far less sticky
  – solves many of the above issues
  – lots of bad news priced in by the -27% drawdown in 2022
  – 10-yr yields falling = supportive of equities
  – investor position is so negative, hard to cause further downside

ECO: Generally light week ahead…

There are many economic reports this week, but few will likely be as market moving as inflationary reports. As shown below, the highlights are:

• May Regional ISM surveys due (Empire 5/15 8:30am ET, Philly Fed 5/18 8:30am ET)
• April Retail Sales (5/16 8:30am ET)
• Housing data (5/16 10:00am ET May NAHB Index, 5/17 8:30 April Housing starts, 5/18 10am ET April Existing Home Sales)

ECONOMIC CALENDAR: Key May data is inflation and ISM, and April was overall “tame”

Key incoming data May

• 5/1 10am ET April ISM Manufacturing (PMIs turn up)Positive inflection
• 5/2 10am ET Mar JOLTSSofter than consensus
• 5/3 10am ET April ISM ServicesTame
• 5/3 2pm Fed May FOMC rates decisionDovish
• 5/5 8:30am ET April Jobs reportTame
• 5/5 Manheim Used Vehicle Value Index AprilTame
• 5/8 2pm ET April 2023 Senior Loan Officer Opinion SurveyBetter than feared
• 5/10 8:30am ET April CPITame
• 5/11 8:30am ET April PPITame
• 5/12 10am ET U. Mich. April prelim 1-yr inflation Tame
• 5/12 Atlanta Fed Wage Tracker April Tame
• 5/24 2pm ET May FOMC minutes
• 5/26 8:30am ET PCE April
• 5/26 10am ET U. Mich. April final 1-yr inflation
• 5/30 Conference Board Consumer Confidence

Key data April

• 4/3 10am ISM Manufacturing Employment/Prices Paid MarchTame
• 4/4 10am ET JOLTS Job Openings (Feb)Tame
• 4/7 8:30am ET March employment reportTame
• 4/12 8:30am ET CPI MarchTame
• 4/12 2pm ET March FOMC MinutesTame
• 4/13 8:30am ET PPI March Tame
• 4/14 7am ET 1Q 2023 Earnings Season Begins Better than feared
• 4/14 Atlanta Fed Wage Tracker MarchSemi-strong
• 4/14 10am ET U. Mich. March prelim 1-yr inflationHawkish
• 4/19 2:30pm ET Fed releases Beige BookTame
• 4/28 8:30am 1Q23 Employment Cost IndexSemi-strong
• 4/28 8:30am ET PCE MarchTame
• 4/28 10am ET UMich April final 1-yr inflationHawkish

POSITIONING: FINRA Margin debt shows positioning is far more bearish than most appreciate

One might think that this doesn’t mean stocks need to rise, even if the data has moved towards the “soft landing” camp. But keep in mind, investors have de-risked and de-levered to a significant extent. We covered much of this recently including the massive swing to short S&P 500 futures contracts and the surge in ICI retail cash balances.

Today, we want to highlight the collapse in FINRA margin debt. The latest figure shows margin debt is now $607 billion:

• this is down -35% since late 2021 and a decline of $330 billion from peak
• during GFC, the FINRA deleverage was $216 billion, so already surpassed
• margin debt as % market cap now 1.59%, matching “dot-com” 2002 25-year low

• In other words, while this might be a marginal positive shift on fundamentals, there is a far greater positioning shift ahead, if the data ends up proving to be “soft landing”

This time series really shows the extent of de-leveraging. The level of margin debt to market cap is at 1.59% and same as dot-com trough

• so any decisive “soft landing” data will shift positioning far more dramatically

POSITIONING: FINRA margin debt highly correlated to equity market

We highlighted how FINRA margin debt has collapsed since 2021 and went into a waterfall decline for much of 2022.

• some investors pushed back saying high margin interest rates is the reason for the decline
• we highlight the relationship between FINRA margin debt changes and S&P 500 returns.
• notice the sharp relationship? Whatever the driver, if FINRA margin debt starts to expand, this is positive for stocks
• and as we previously noted, FINRA margin debt as % equity is the lowest since dot-com, implying the figure is not likely to further shrink.

SMALL INVESTOR POSITIONING: Even small investors are ultra-bearishly positioned

As Sentiment Trader’s Jay Kaeppel highlights, there is a significant increase in small-speculator short positioning:

• notably, this figure is the most short since the series began in 1990
• think about that, a 35-year high in shorts by small investors
• again, highlighting how lopsided the positioning is currently

STRATEGY: Focus on Industrials, a week to make a tactical positive bet

Both the ISM PMI and S&P Global US PMIs are released on Monday:

ISM Manufacturing PMI has been better than consensus.

• Actual 47.1 vs Street 46.8 and last month 46.3

S&P Global US PMIs has come in slightly lower than consensus, but remains above 50.

• Actual 50.2 vs Street 50.4 and last month 50.4

Whenever PMIs bottom (see below), Industrials tend to bottom. This first chart shows rolling change for US PMIs and US Industrials returns.

This distribution table puts this in a clearer light. When PMIs are rising and from low levels, Industrials see strong gains.

• Since 1948, when PMIs are over 50 and are rising (n=60), Industrials see positive forward 6M and 12M gains of 85%/95% of the time with median gains of +12.6%/21.5%, respectively.

• Those are very favorable risk/reward and high absolute return opportunities.

Industrials are oversold vs S&P 500 on 20D %-change, with a z-score of -1.2.

• The top chart is the relative price ratio of Industrials vs S&P 500
• The bottom is the z-score of the 20D % change.
• The most recent 4 times this was seen, Industrials staged strong rallies vs the broader market.

• This is not that different than the signal we highlighted two weeks ago regarding FAANG/Technology. And we know that FAANG powered higher in the past two weeks

And Industrials are the most oversold vs other sectors, particularly against Staples.

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34 Granny Shot Ideas: We performed our quarterly rebalance on 4/26. Full stock list here –> Click here

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