“The rivalry is with ourselves. I try to be better than is possible. I fight against myself, not against the other.” ~Luciano Pavarotti

Good evening:

With the first half of 2023 in the books, the U.S. stock market is up more than 16% YTD, ahead of schedule for Tom Lee’s prediction for the market to end the year 25% higher than it began. The Nasdaq 100 had its best start ever, topping 1998, up 39.74% YTD.

In January, Lee cited the “rule of first 5 days” as one reason why the market would rise in 2023. Now, he’s again turning to history.

Since 1950, there have been 22 instances when the S&P 500 is up by more than 10% at midyear, and 82% of the time, the market continued to climb in the year’s second half. This win ratio rises to 89% when the preceding year was a down year (as it was in 2022.) These historical cycles are meaningful and important because, as Lee is fond of saying, there is “nothing new under the sun.”

But it’s not just about historical trends. In recent weeks, Lee has repeatedly countered bearish fears of an imminent hard landing by asserting that “the economy is slipping into expansion.” Lending support to that view, the Commerce Department on Thursday significantly revised its Q1 GDP numbers and revealed that the U.S. economy grew 2% (annualized), rather than at the previously reported 1.3%.

“Our constructive view on stocks is based on the idea that many forward-looking indicators of inflation undershooting consensus,” he said, arguing that this would result in the “Fed having to do less.” Forward-looking numbers on housing and rent this week – the Realtor.com rent report and the S&P Corelogic Case-Shiller home price index – did just that. And today (Friday), core PCE came in below expectations, and headline PCE came in even softer.

Looking forward, Lee said, “We think the next PCE report (for June) coming at the end of July will be telling, as this should show a steep drop off in YoY growth rates due to the June 2022 surge of 0.99% for the month.”

This is shown by our Chart of the Week, courtesy of our astute intern, Liana Kaye-Lew:

The bottom line is that for Lee, his base case and constructive outlook both remain intact.

Sentiment seemed to improve slightly this week. Fed Chair Jerome Powell’s hawkish warning on Wednesday about the possibility of 50 bp of additional rate hikes before the end of 2023 did little to affect the markets, with both the S&P 500 and Nasdaq ending the day nearly flat. (Powell’s remarks came during a panel of central-bank leaders that included ECB President Christine Lagarde, Bank of Japan Governor Jazuo Ueda, and Bank of England Governor Andrew Bailey.)

That’s something Head of Technical Strategy Mark Newton noted as well during our weekly huddle: “I think people are slowly but surely realizing that standing on the sidelines is just not going to pay off and that they're starting to put more money to work. People I've talked to have still been pretty cautious but they're coming around, and it hasn't just been Technology.”

Nevertheless, sentiment is still at a level where you want to say that the market is going to sell off, Newton warned. “Sentiment has gotten more optimistic, but not nearly to those levels.” In his view, “When you hear all the people in the media scratch their head as to why the market's moving [up], generally that's a healthy sign for those still looking to participate.”

“Here’s a pretty interesting ratio that frequently provides very generalized clues about whether the market is favoring a risk-on or risk-off environment. It’s a chart showing the ratio of consumer discretionary versus staples,” he said. “Back in December you saw it turning up, when discretionary gained strength and staples started to roll over. The ratio moved up sharply and peaked right at February 2nd. That's when markets topped briefly [...] Then the same thing happened back in April. This happened actually a month before markets really broke out, which I would argue took place on May 17th. And that's when we really saw a very broad-based movement into many different sectors. So based on this, I see us challenging if not taking out those highs, no evidence of this rolling over.”

Other takeaways from Newton this week:

• On staying bullish entering the second half: In the commentary accompanying the latest update to his closely watched Upticks stock list this week, Newton wrote: “Overall, bullish positioning continues to look correct into the start of Q3, despite ongoing economic, geopolitical and earnings-based concerns. Barring evidence of any technical deterioration, it’s likely that markets will push even higher into mid-to-late July ahead of a possible minor correction into August.”
• On breadth expansion: The broadening out of the rally, which started about a month ago, is really important. You see the move into discretionary and into industrials. A lot of people said, “Tech is overbought, it’s going to join the laggards.” If anything, the opposite has happened. That gives me reason for optimism in the second half.
• On continued tech strength in the second half: It’s been an incredible recovery at a time when people have been really slow to embrace this rally. I talk with a lot of institutions that (are) chasing tech stocks and buying into this rally, for a lot of the right reasons. So you want to stay in technology, but you also want to diversify into other groups. I would argue materials and industrials make a lot of sense with the dollar more on the verge of turning back lower.
• On earnings being better than expected: It’s been fundamental bullishness along with technical bullishness. Sentiment is not all that positive yet, and the breadth has been expanding. There are reasons why people should ignore all the news and focus on what’s working.
• On concerns around high valuations in tech: Tom Lee (had) a stat that we’re priced at about 16 times when you throw out large-cap technology stocks. The market’s never going to sit right where it should based on intrinsic value or earnings. It could go way higher or lower than what people anticipate. I don’t look at earnings as a means to time the market. I see earnings revisions are starting to bottom out. I don’t see the market as being overly expensive.
• On his institutional conversations: When I talk to institutional investors, they say, “Well, it’s overbought,” or, “There are only a few stocks driving it.” These are all reasons people have missed the rally, and they’re not embracing it. Those aren’t signs of ebullient speculation where everyone is buying call options and they’re making money hand-over- fist.
• On a pending recession: The “R” is likely a couple of years away. It’s coming, but it might not come this year. I don’t think we’ve seen the effects of a lot of the rate hikes.

Other takeaways from Lee this week:

• On the second half: The market’s done great. The natural question becomes, “What can we expect for the second half?” You might wonder, can we continue to make gains? It turns out, yes…I think it’s sufficient to say our second-half view of reaching 4,700 is really in line with history. Those who are bearish - the burden’s really on them to prove the market would fall.
• On high cash levels: There’s $5.5 trillion (in cash on the sideline) right now. At the start of the year, there was $4.7 trillion. After a 16% rally year-to-date, now there’s more cash on the sidelines. Doesn’t think kind of make you realize the odds favor stocks rising?

Elsewhere

“INS018_055,” the first experimental drug designed by an artificial intelligence, has moved to Phase II clinical trials in the U.S., having successfully passed the first phase of tests demonstrating safety. Hong Kong-based Insilico Medicine hopes the second phase will show that the medication is not just safe, but also effective in treating patients with idiopathic pulmonary fibrosis. The company also hopes the drug will eventually prove effective at treating kidney fibrosis, though clinical trials for that condition have not yet begun.

Dr. John B. Goodenough, a co-inventor of the lithium-ion battery that powers today's smartphones and electric vehicles, died this week at age 100. Prof. Goodenough studied with Enrico Fermi at the University of Chicago and did his Nobel Prize-winning battery research at Oxford in the 1970s and 1980s. Goodenough was also regarded as instrumental in the development of random access memory (RAM).

The Federal Reserve announced that its latest stress test showed that “large banks are well positioned to weather a severe recession and continue to lend to households and businesses.” All 23 banks passed the test, which this year featured a simulation of “a severe global recession with a 40 percent decline in commercial real estate prices, a substantial increase in office vacancies, and a 38 percent decline in house prices.”

Every South Korean became at least a year younger by law this week, as authorities moved away from a traditional age-counting methodology that considers babies as one-year-olds at birth and advanced everybody’s age on January 1 rather than their birthdays. (Thus, a baby born on December 31 would be considered two years old a day later.) Going forward, South Koreans will switch to age-counting by birth date, as is done in most other parts of the world.

And finally: Further supporting our view that inflation is cooling, the American Farm Bureau Federation reported that the cost for a Fourth of July cookout is down 3% from 2022. The menu for the hypothetical cookout includes cheeseburgers, chicken breast, pork chops, pork and beans, potato chips, potato salad, lemonade, ice cream, strawberries, and chocolate chip cookies.

Notice:  U.S. stock markets and Fundstrat offices will be closed on Tuesday, July 4, 2023 in observance of Independence Day. 

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