S&P 500 ended February down ~2% and the weakness has caused many investors to return to full “bear” mode. The fact that investors are so quick to flip cautious is a sign that sentiment still leans bearish — think about that. If investors were constructive, the narrative would be “buy the dip”
- instead, many think investors are about to walk into boiling oil (ala tiktok video below)
- with conviction based upon the “hot” inflation and economic data of January
- but as we noted multiple times, there are reasons to view Jan strength in inflation as countertrend
- moreover, February was set to be a “payback month,” meaning the probability of gains in the month were low
The good news, the set up for March is entirely different. Keep reading if you would like a perspective.
PAYBACK (aka Calendar): Feb = payback, March+April = Fire
As you know, we are using the composite of the “rule of 1st 5 days” as the template for 2023 — this is a calendar template. The other is the breakaway momentum (see note Monday). And as we flagged earlier this year, Feb is a “payback” month:
- of the 7 precedent instances, Feb is up only 57% of the time, which is worst of any calendar month
- median gain of +0.2% is the worst of any month
- hence, Feb is not a month that investors can arguably see gains
- Feb 2023 sort of validates this template still valid
Next 8 weeks is “buy the dip”
But this same template says March + April should be very good months for stocks:
- win-rate is 100% or 7 of 7 times March is a gain
- Median gain of March and April are the strongest
- Even stronger than January
- Hence, we think the next 8 weeks is a period of “buy the dip”
For those tactically focused, this composite below shows March 7 is the ideal window:
- this coincides with Mark Newton, Head of Technical Strategy, who sees markets chopping here near term
- but this softness is a buy the dip moment, as the next 8 weeks should be among the strongest
VALUATION: Ex-FAANG, S&P 500 P/E is 14.8X, hardly demanding
We hear investors say the market is too expensive. But this is distorted by the higher multiples of FAANG, and we think the higher multiples of FAANG are justified.
- ex-FAANG, P/E is 14.8X
- this is hardly demanding
- Energy is 10.5X, whoa
- so, still think the equity market is expensive?
TECHNOLOGY: Still our favorite Sector pick for 2023
As we noted in our 2023 outlook, Technology is our top sector pick, which we expect to be led by FAANG.
- Technology and FAANG are now established meaningful breakouts as shown below
- this after sliding down the slope of hope in much of 2022
- this reversal has fundamental arguments
TECH EPS: Bottoming before the overall market
The two best performing sectors YTD are:
- FAANG +1,180bp outperformance (vs S&P 500)
- Technology +210bp
- Defensives have been terrible, despite those arguing for a recession
- Tech/FAANG EPS has been slightly better than the overall market
- Thus, leadership is coming from groups with EPS bottoming
7 of 14 sub-groups in Technology seeing upward bias in EPS revisions
Take a look at 2023 EPS in the 14 sub-groups (GICS 4) of Technology.
- Half, or 7 of 14 are seeing upward bias in 2023 EPS revisions
- So, those saying Technology is a “sell” are overlooking that EPS momentum is turning positive
INFLATION: U Mich 1-yr shows consumers expect less inflation even as Jan inflation surges
Take a look below at U Mich 1-yr inflation compared to Core PCE MoM (annualized).
- which one is showing a clearer trend?
- there is a lot of choppiness in the Core PCE data and this surge in January seems incongruent with recent trends
- Why could core PCE MoM be at the highest monthly gain since July 2022?
- Did inflation suddenly surge? Or are there issues with the seasonals?
STRATEGY: VIX matters far more for 2023 returns than EPS growth
Our data science team compiled the impact on 2023 equity returns from variables:
- S&P 500 post-negative year (2022)
- the varying impacts of
- VIX or volatility
- USD change
- Interest rates
- EPS growth
- All of the 4 above, positive or negative YoY
- Data is based on rolling quarters and summarized below
The surprising math and conclusions are as follows:
- most impactful is VIX
- Post-negative year (rolling LTM)
- if VIX falls, equity gain is 22% (win ratio 83%, n=23)
- if VIX rises, equity lose -23% (win ratio 14%, n=7)
- I mean, this shows this all comes down to the VIX
- EPS growth has little impact
- If EPS growth is negative YoY (likely), median gain +14.8% (win-ratio 70% n=33)
- If EPS growth is positive YoY, median gain is 15.5% (win-ratio is 78%)
- Hardly a sizable bifurcation
As the scatter below highlights, we can see the sizable influence of the VIX. Even in all years, the VIX is a key factor:
- in our view, if inflation falls sharply
- and wage growth slows
- Fed doesn’t have to cut, but this is a dovish development
- we see VIX falling to sub-20
- hence, >20% upside for stocks
And as shown below, EPS growth has a somewhat important correlation, but hardly as strong as VIX changes.
- the difference in median gain is a mere 70bp (positive vs negative) post-negative year
- the importance of EPS growth is stronger in other years
STRATEGY: Financial conditions should ease in 2023, driving higher equity prices. Technology, Discretionary and Industrials levered to easing FCI
The “base” case for 2023 should be below. That stocks gained >1.4% in the first 5 trading days, and this portends strong gains for the full year:
- Post-neg year + up >1.4% on first 5 days
- Day 5 to first half median gain is 9.5%
- Full year median gain is 26%, implies >4,800 S&P 500
- 7 of 7 years saw gains.
Those 7 precedent years are shown below.
- the range of full year gains is +13% to +38%
- so, this is a VERY STRONG signal
- the two most recent are 2012 and 2019
- we think 2023 will track >20%
The path to higher equity prices is discussed above:
- core inflation falling faster than Fed and consensus expects
- wage inflation is already approaching 3.5% target of Fed (aggregate payrolls)
- Fed could “dovishly” leg down its inflation view
- allowing financial conditions to ease
- bond market has already seen this and is well below Fed on terminal rate
BASE CASE: The “maths” for what to expect in 2023, post a “negative return” year (2022)
Question: how common is a “flat” year? Our team calculated the data and it is shown below:
- since 1950, there are 19 instances of a negative S&P 500 return year. In the following year,
- stocks are “flat” (+/- 5%) only 11% of the time (n=2)
- stocks are up >20% 53% of the time (n=10)
- yup, stocks are 5X more likely to rise 20% than be flat
- and more than half of the instances are >20% gains
So, does a “flat year” still make sense?
As shown below, these probabilities are far higher compared to typical years:
- since 1950, based upon all 73 years
- stocks are “flat” 16% of the time vs 11% post-negative years — BIG DIFFERENCE
- stocks are up >20% 27% of the time vs 53% post-negative years — BIG DIFFERENCE
- see the point? The odds of a >20% gain are double because of the decline in 2022
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37 Granny Shot Ideas: We performed our quarterly rebalance on 1/30. Full stock list here –> Click here
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