Consensus still looking for a recession and S&P 500 3,100 or lower but US tracking for a "growth scare" -- July CPI could fall to lowest rate since January 2021...

Over the past month, bond markets have drastically reduced their expectations for Fed tightening. This is evidenced by looking at Fed futures below:

• after June FOMC, markets saw Fed funds (mid-point) peaking at 3.81% in April 2023
• post July FOMC, markets now see Fed funds peaking at 3.28% in January 2023
• 53bp less on peak FF, or 2 hike reduction
• Fed funds peaking 3 months earlier

In other words, the bond market made a serious “dovish pivot” in pricing Fed funds into 2023. Is it any wonder that equity markets have found footing in July?

If markets are bottoming now, it is because 2022 is a “growth scare” and not a recession

As many of our clients know, we believe August 1982 is the best analog for 2022. That equities are inflecting because markets now see a shift in Fed’s “anti-inflation” fighting measures. That, in our view, is that the US is tracking closer to a growth scare:

• growth scare is a slowdown in economic growth like we are seeing
• but an avoidance of a full-blown recession
• if such is the outcome, equities do not have to fall 30% or more as consensus argues

The tweet below is emblematic of the skepticism of equities currently. The comments from @KobeissiLetter are useful, but the central view is this is a classic economic contraction.

• this is where our thesis is wrong
• if the US enters a full-blown recession
• not sure there is further downside
• but the recovery to new highs before YE would be harder to achieve

…Inflation is set to fall sharply beginning in July CPI

Forecasts for July CPI (released 8/10) are now capturing the slowdown in inflationary drivers seen in many leading and alternative data indicators:

• recall, we noted that there has been a sharp slowdown in inflation including food, gasoline, travel, housing, etc
• Cleveland Fed inflation nowcasting now shows July CPI tracking to 0.27%
• This is a ~3% inflation rate, a collapse from the 9%-12% annualized rates seen in all of 2022

If Cleveland Fed is correct, inflation lowest since January 2021

If Cleveland Fed forecast is correct:

• inflation at 0.27% is 3.24% annualized
• this is the lowest rate since January 2021
• this would reverse months of elevated inflation readings

Inflation swap markets see <2% annualized inflation for the next 6 months

In fact, inflation swap markets don’t see the coming July CPI as necessarily a fluke:

• July 2022 to December 2022 CPI forecast to be below 2% annualized
• 6 consecutive months of CPI <2% annualized
• whether this is the new baseline is not known
• but we know this will have a major effect on inflation psychology

There are multiple drivers of falling inflation in July, which we have discussed in prior comments. These are gasoline (down), bloated inventories aka bullwhip (discounts), food prices (showing up finally) and even travel data such as hopper.com (down big).

• the WSJ article below notes that the fall in food prices is global
• food is 10% of the basket in the US but as much as 40% in other nations
• thus falling food arguably lowers inflationary pressures outside the US as well

Even wages are set to slow, despite the elevated readings by Atlanta wage tracker

There remains the concerns about the tight labor market and the risk this fuels higher wage growth. In fact, the latest Atlanta Fed wage tracker (a monthly survey) shows wages YoY surging in July to nearly 7%.

• a challenge with Atlanta Fed wage tracker is this shows YoY growth
• so it is harder to distill the month-over-month changes which are key to understanding wage trends
• but the fact this is rising YoY suggest wage pressures are accelerating

Goldman Sachs Economists, by contrast, believes wage growth has slowed

But in contrast to the Atlanta Fed wage tracker, Goldman Sachs believes there is a slowdown in wage growth coming. In fact, in their recent note:

• they see wage growth to slow to 4.5% by YE 2022
• and <4% by YE 2023
• this would be compatible with 2% inflation targets in 2024
• hence, there is some reason to believe wage pressures are easing

In fact, indeed labs data shows there is a serious slowdown in job postings in July. As shown below:

• the number of openings in July 2022 are below July 2021

• a decline in YoY has not been seen at any time during the post-pandemic period
• how could one view a labor market as so strong?
• if job openings are down YoY

STRATEGY: Only 6 of 15 Sellside Strategists see >5% upside into YE, bearish outlook = contrarian buy signal

Seasonally, 2H of a midterm year is positive and yet, an unusually low number of sellside strategists see upside:

• of 15 strategists survey by CNBC
• only 6 see upside >5% into YE2022, or above S&P 500 4,300
• since 1950, median 2H return in a midterm year is >8%
• one strategist sees >10% downside to S&P 500 3,600

COUNTERTRADE: Majority of Sellside Strategists see equity downside into YE

And despite this bearishness by the sellside, technicals are supportive of equities. As Mark Newton, Head of Technical Strategy at Fundstrat, notes:

• breadth expansion in July is a positive development
• as is the strength in Technology stocks, which could build upon gains in August
• he is “buying the dips” and doesn’t see a retest to recent lows as necessary

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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