What Our Clients Are Talking About Behind The Scenes

Well, last week was quite the rollercoaster ride with a nearly 5% down move in the S&P 500 from record highs, and then it bounced sharply and recovered nearly 70% of the down move by Friday’s close.  The drivers for the pullback were early week fears of the upcoming inflation data releases that were released on Wednesday and Thursday, which were the CPI and PPI, respectively.  Indeed, both metrics came in well above the Wall Street consensus forecasts and the headlines were filled with stories of surging inflation pressures.  The benchmark fell quite quickly down to the 50-day moving average.  A level where traders would normally consider a key technical analysis support area. 

The combination of both holding above the critical price level and Friday’s Retail Sales data release, which came in softer than expected, helped propel the S&P 500 to strongly end the week.  Over the past 4-6 weeks, I have consistently warned that the U.S. equity markets could experience short bouts of selling pressure as a result of headline macro news.  Importantly, however, I have also suggested that any weakness should be viewed opportunistically as my proprietary investment process continues to signal that the backdrop for stocks remain favorable.  As we begin this week, a deep dive into my most important factors clearly shows that they remain favorable for my longstanding investment themes.  With that being said, I reiterate my bullish overall market thesis and based on my proprietary research will keep viewing price moves that are divergent to my medium-term expectations views as chances to take advantage of the tactical price action. 

When the investment environment gets challenging or “noisy”, investors can be overly impacted by either headline news or tactical market price action that leads to sub-optimal decision making.  Yet, if one has a disciplined investment process, it can be value added in helping an investor keep their emotions in check.  My colleagues and I here at FSI have spent over two decades developing objective tools to help investors identify rewarding investment opportunities, especially when the equity environment becomes more difficult.  We use analytical techniques that are based on data driven approaches as the foundation for our research and idea generation to help our subscribers stay grounded and properly positioned to take advantage of the dominant trend.

ISSUES

• Investors had lots of questions about the suddenness of the decline during the first half of the week and what kind of tactical shifts that one should be making…

• …But, this quickly shifted intra-day Thursday, and questions went back to how one should be positioned as the selloff concerns disappeared as fast as they appeared. 

• Well, I hope you are not getting bored of reading this one yet again, but Macro Macro Macro continues to dominate my institutional client interactions, but few questions on interest rates. 

• Several meetings were with Global investors and I was asked about positioning between the U.S. versus the ex. U.S. world. 

• Although I have worn nearly everyone down with my preference for Value/Cyclicals/Recovery/Reflation, there are many questions about what to do with Technology at this point. 

• There were nearly zero questions about the earnings season and how companies didn’t perform as well as expected post their respective 1Q21 operating results.

• I did get many questions asking me to compare/contrast my views on Technology, Energy, and Staples with those of my colleague, Tom Lee, who recently recommended a large shift away from Technology, increased his weighting in Staples, and has a very bullish outlook on Energy.  Based on my work, I have only lowered my weightings (not abandoning) for Tech back in November, I am also constructive on Energy, which I have upgraded 3x from October to March (not to FULL bullish and NOT my top sector), and am still full underweight Staples.

SPECIFIC QUESTIONS

• What does your proprietary earnings revisions dominated sector 8-panel methodology show for Technology, Energy, and Staples since your views now seem to be different than Tom Lee’s?

• SMid caps have been underperforming since mid-March. Are you still favorable on this part of the cap scale to outperform going forward?

• When looking at global equity allocations, what does your work suggest for the U.S. vs the non-U.S.?

• Were there any changes in your tactical indicators this week?

MY ANSWERS

What does your proprietary earnings revisions dominated sector 8-panel methodology show for Technology, Energy, and Staples since your views now seem to be different than Tom Lee’s?

I will briefly describe what the 8-panels are showing for all three sectors without actually providing them.  If you’re unfamiliar with my methodology, I am including my Intro to Methodology link below. 

Fundstrat Global Advisors:  Global Portfolio Strategy — Intro to Methodology

STAPLES.  I will start with the clearest one first, which is Staples.  Yes, the sector is relatively oversold and could get a short-duration and small magnitude rally at any moment, but my work suggests any bounce would likely be a countertrend and that there is still further underperformance ahead for Staples.  Why do I feel strongly about this?  Well, the sector’s ASM indicator is falling and has much more room to fall before it reaches a relative negative extreme, which ultimately would be a contrarian positive.  Interestingly to me, my work is acting the way it normally has when the U.S. is coming out of both an economic weak period and trough in corporate profits. 

Bottom line vs. Tom:  my work could support a small countertrend tactical bounce, but a more strategic upgrade is at least 5-8 months away. 

TECHNOLOGY and ENERGY.  Although their performances have been quite different in recent years, their current 8-panels are similar.  Their respective relative valuations are not excessively overvalued, and their PRO readings are constructive.  Significantly, their ASMs are also supportive and not extreme.  Thus, the weight of the evidence that is important in my process says that both sectors should be slightly above benchmark.  However, to put this in perspective, I have been recommending lowering Tech exposure, especially the less cyclical areas, since November when I downgraded the sector, and I have been suggesting raising Energy exposure with my three sector upgrades that started in October.  So, two sectors at the same place, but my work has been headed in different directions. 

Bottom line vs. Tom:  my work does not support as large a cut in exposure for Technology although I have clearly been moving away from the sector for more than six months.  Additionally, my key indicators do not support the mega bullish Energy call at this time, but my analysis is certainly more favorable than it was back at the start of 3Q20.  So, yes, we have some absolute differences for these sectors, but we are moving in the same direction, which I think is the bigger and more important takeaway.

SMid caps have been underperforming since mid-March. Are you still favorable on this part of the cap scale to outperform going forward?

YES. My research has been and remains tilted in favor of SMid caps relative to Large Cap.  So why the underperformance since mid-March?   My research points to one main factor.  

Simply, when looking at IWM as the proxy for SMid and SPY to represent Large, IWM had one of the largest and sharpest periods of outperformance in the history of our database.  Indeed, since 9/25/20, IWM’s relative performance went nearly uninterrupted until mid-March and outpaced the SPY by over 30 percentage points.  Thus, SMid was overdue a well needed consolidation. 

The estimates revisions for the SMid universe remain quite robust and I expect it to strengthen further both absolute and relative to Large as the U.S. experiences a broader based and national economic recovery.  It is my view that as each day passes, the evidence of this will become harder and harder to ignore, which will continue to drive the relative estimate revision advantage; and now that IWM is also relatively oversold, it is poised to resume its unfinished period of outperformance.

When looking at global equity allocations, what does your work suggest for the U.S. vs the non-U.S.?

My work still recommends having less U.S., but… this needs more color to truly understand what my work is showing.  First, some context.  My analysis has led me to be Overweight the U.S. for most of the past seven years, which was out of consensus for a Global Equity Strategist. 

In my 2021 outlook publication ( 2021 Outlook ), I suggested moving one’s U.S. weight from full above benchmark to just above Neutral.  So, yes, I have been recommending lowering one’s exposure in the U.S., but the devil is in the details.  Almost all the suggested cutting should be coming from Large Cap Technology.  My work is still relatively bullish on the prospects for domestic Financials, Industrials, CD, and SMid versus the World.  At this time, my work is cannot support a major exiting of the U.S.  I suspect that as 2021 evolves there will come a point when my key indicators flash an important signal that other regions of the World are relatively more attractive.  But not at this time.  The U.S. still has the best earnings revisions in the World and in my opinion the best mix of Monetary and Fiscal policies.  This is a tough mixture to bet against.  So, let’s start looking at other regional opportunities, but be more discerning with the implementation at this time.

Were there any changes in your tactical indicators this week?

YES, there was more than one.  Unexpectedly, from non-extreme positive levels, my key aggressive tactical indicators — HALO-2, and V-squared (see explanations at the end of the note) — sharply flipped to negative near the open on Tuesday and the hot CPI number on Wednesday caused them to sink further.  While digesting those new negative tactical signals and their implications, which normally have a time duration of 2-4 weeks, they suddenly reversed back to favorable on Thursday afternoon after making non-extreme bottoms.  This is unusual for my indicators to provide two opposing readings so closely together, but not unprecedented.

I have been trying to keep the Whispers streamlined by making it packed with conclusions and light on the supporting evidence and charts.  However, to illustrate what occurred, I am including the HALO-2 / V-squared charts below this week as I thought it would be insightful.  

So, what is the main conclusion from this? My aggressive tactical indicators are favorable and aligned with my ongoing constructive view for the overall U.S. equity market.

Source:  Fundstrat Global Advisors and Bloomberg

Bottom line: My work remains bullish for the overall U.S. equity market.  Notably, my other recommended themes — Value/Cyclicals over Growth/FAANG, and SMid over Large— and preferred sector positions — Financials, Industrials, and Materials as Full Above Benchmark and HC, Staples, Utilities, and Real Estate as Full Below Benchmark — all remain intact. 

Additionally, I continue to echo that there remains a decent probability that there will be bouts of volatility and headline risk in the weeks and months to come.  Therefore, if/when it occurs, I am still recommending that investors use relative weakness in the sectors/stocks that my work continues to flag as favorable opportunities and avoid the areas that have unfavorable indicators.  This has been our ongoing strategy since my analysis continues to strongly suggest that investors STAY THE COURSE.  As a result, it is my expectations that the U.S. equity market will keep climbing the “Wall of Worry” even though there are stillincreasing levels of anxiety  among institutional investors. 

Also, my key indicators maintain that as we keep moving into the back half of 2021 the probability of more evidence showing the broad-based reopening of the U.S. domestic economy will rise each week.  Undeniably, this decisive shift towards recovery underlies my view that as the signs of normalization increase the tailwinds at the back of a resilient  equity market rally should further intensify.  I am still advising investors stay disciplined and focused on the bigger picture and not the day-to-day market action so one can keep benefiting from the favorable backdrop for equities.

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Definitions of HALO, HALO-2, and V-squared

HALO = The proprietary Fundstrat Portfolio Strategy Halo Model is a multi-factor model that attempts to predict the forward 1 – 6 month relative performance of a group.  The goal is to help both strategic accounts better time their implementation strategies that would be consistent with our more strategic conclusions derived by our sector/sub-industry 8-panels as well as our stock specific Estimate Revisions Model (ERM), and to generate tactical ideas for aggressive trading accounts. 

HALO-2 = The proprietary Fundstrat Portfolio Strategy HALO-2 Model is the raw tactical data behind our standard HALO multi-factor model described on the previous page.  It is useful for identifying aggressive tactical trading bottoms for the S&P 500.   

V-squared = The proprietary Fundstrat Portfolio Strategy V-squared indicator at its lowest level shows the ratio of VXV (the 3-month CBOE S&P 500 Volatility Index) and the VIX (the 1-month CBOE S&P 500 Volatility Index).  This tool is also useful for identifying aggressive tactical trading bottoms for the S&P 500.