Powell testimony (3/7) suggests he wants financial conditions to tighten. But data remains key. Curious divergence of JOLTS vs LinkUp implies Feb “payback”. Per LinkUp, 90% industries see notable declines in openings MoM

Powell was a bit more “hawkish” than expected in his first day of testimony to Congress (Wed is House). Specifically:

• Powell indicated Fed is prepared to raise rates at a faster pace if warranted. His statement “As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
• In short, the Fed is making two changes that impacted markets. First, it is saying it is swayed by the Jan “hot” data and the prior revisions to inflation. Second, Fed also implying the “bar” is raised for how Fed sees slowing the pace.
• The reaction in markets was a jump in March and May hike expectations. An additional +15bp of higher rates, or 0.4 hikes, was priced in as shown in the first chart below. The YE Fed Funds moved by a similar amount while the 2-yr yields rose +12bp to >5%.
• In a sense, Powell’s comments sort of imply the Fed would like to see Financial Conditions tighten. And this higher level of hikes is the market’s attempt to reflect this.
• But while this had an effect of causing a rise in the VIX (+6% to 19.6) and hurting equity prices (down -1.5%), the reaction in longer term rates was muted as the 10Y and 30Y yields fell slightly.
• Hence, this adds to the near-term turbulence, but actually, this testimony is not really changing anything as the Fed actual path is a function of what happens with inflation.
• The forward path of inflation, of course, is not yet known but the leading indicators show future progress is in the works.
• Jan JOLTS (job openings) is released 3/8 at 10am ET and this will impact markets. As will Feb NFP (jobs) on 3/10 at 8:30am ET. We have a small JOLTS preview below. There is some Jan seasonal distortion (JOLTS always stronger in Jan), this looks to us as an aberration.
• Linkup and Indeed data show a sizable ~1.0 million undershoot vs JOLTS currently, a gap never seen before. And as the Linkup industry data shows, many “core services” jobs are seeing decline in openings in February. JOLTS is Jan data, so Linkup and Indeed are already showing softer Feb numbers as well.
• Does this turbulence hurt our view for the next 8 weeks? It is a setback but we think it is important to respect the calendar. Stocks are entering what could be the best 8 weeks of 2023.
• The calendar based on “rule of 1st 5 days” (post-negative years) remains useful in 2023. This suggests an 8 week rally leading to +7% gains thru end of April.
• Recall, this is based on the 7 precedent instances of similar conditions.
  – this called Jan rally . HAPPENED
  – “payback” 2/16 to 3/7, HAPPENED
  – today is 3/8, TODAY
  – And now a rally thru end of April?

Bottom line. We remain constructive on equities. While Fed is clearly showing it is respecting and incorporating the “hot” Jan data (plus prior revisions) to its view, this also means the key remains the forward path of inflation.

SENATE TESTIMONY: March and May Hike expectations rise, but long-rates and inflation unchanged

The immediate reaction was a rise in March and May FOMC rate expectations:

• +0.43 and +0.14 additional hikes for March/May or 0.60 hikes essentially
• meaning roughly +15bp higher rates, or 75bp in total hikes over next 2 meetings

Additionally, YE Fed Funds Dec 2023 contract shows this same +17bp of higher rates carrying into YE.

• in other words, a higher terminal rate raised by +17bp
• but the 10-yr bond was unchanged
• while FCI, or financial conditions, tightened, the equity market is valued off the 10-yr bond
• if the 10-yr is unchanged, why should equity prices change?

And as shown below, the breakevens for 6M and 12M forward did not react to Powell.

• this is a reminder the Fed did not make any statements regarding future inflation
• merely their reaction to current data (Jan + revisions) and how they will react to future conditions

CALENDAR: Key incoming data starting March 10

I want to re-focus on the calendar.

There is lot of incoming economic data this week (durable goods, housing, unit labor costs and ISM) but for the key inflation-related data, there is a bit of a dead spot until early March. As shown below, this really starts March 10th:

• 3/7 10 am ET Powell testifies to Congress Senate Banking Committee
• 3/8 10am ET Powell testifies to Congress House Fin Svcs Committee
• 3/8 10am ET JOLTS Job Openings (Jan)
• 3/8 2pm ET Fed releases Beige Book
• 3/10 8:30am ET Feb employment report
• 3/13 Feb NY Fed survey inflation exp.
• 3/14 6am ET NFIB Feb small biz survey

• 3/14 8:30am ET CPI Feb
• 3/15 8:30am ET PPI Feb
• 3/17 10am ET U. Mich. March prelim 1-yr inflation
• 3/22 2pm ET March FOMC rate decision
• 3/31 8:30am ET PCE Feb

JOLTS: Are seasonals impacting JOLTS vs Linkup vs Indeed?

There is a curious divergence in JOLTS vs other measures of job openings like Linkup or Indeed.

• JOLTS Jan consensus is 10.546mm openings, down from Dec
• But Linkup implies 9.7mm and Indeed data implies 10.2mm, so a sizable difference
• JOLTS is severely lagged, so we show only Jan vs Jan data but the Feb for Linkup and Indeed is even lower openings

In fact, Feb LinkUp shows that 90% of Industries show a decline in openings

This is a huge deterioration from Jan where the majority of industries had higher openings MoM.

In fact, “tireless” Ken, head of data science research at Fundstrat, shows that Jan JOLTS tends to have a positive seasonal bias. This suggests we could see an upside beat in JOLTS (which is supposed to be seasonally adjusted).

And if one has a doubt about LinkUp data in Feb. Take a look below:

• seasonally adjusted
• Linkup openings are tanking
• Only time it has declined in Feb since 2013, or past decade

STRATEGY: Stocks uptrend remains intact, but the 20-day is a key level near-term

Despite the sell-off in equities Tuesday, the uptrend remains intact. While those bearish view stocks as in a downtrend:

• the chart below shows the uptrend firmly intact
• and S&P 500 bounced off 200D
• the faltering at the 20D is 4,049
• it would be good to see the S&P 500 regain this level, which is 54 points higher than here.

But the calendar remains supportive. Below is:

• the composite for the 7 precedent years when stocks >+1.4% and negative prior year
• 7 of 7 times the 8 weeks March to April positive
• Median gain is +7%
• This implies 4,250 or so on S&P 500

RALLY: 6 reasons we see a rally next 8 weeks

Here are the reason we see equities gaining in the next 8 weeks:

• The last of the “hot” inflation data was the 4Q ULC (unit labor cost) at +3.2% and beginning next week, will be incoming February economic and inflation data, which we believe will show “softer” jobs and “softer” inflationary pressures. This will reverse, to an extent, the somewhat alarming surge in inflation and jobs data of Jan (part seasonal, part noisy data).
• Fed chair Powell actually kicks off this period with his semi-annual testimony to the Senate Banking Committee and House Financial Services Committee and we expect Powell to reinforce the “data dependent” message. Meaning, +25bp is the path for March FOMC, barring evidence of continued acceleration of inflation. Fed’s Bostic said the same essentially yesterday in his speech.
• The bond market will likely pivot dovish in March. The “hot” Jan inflation data caused the bond market to price in higher odds of +50bp in March and April, and Fed speak seems to be pushing back against that — meaning, Fed is less hawkish than recent move in bonds.
• Falling VIX. If the incoming data tilts the way we expect (“softer”), then bond volatility should fall, which supports a stock rally in March to April. This means VIX could fall, and a falling VIX is supportive of higher equity prices.
• Seasonals are also a strong argument. We have been using the composite of “rule of 1st 5 days” using the 7 precedent years where gains >1.4% in the first 5 days (ala 2023). This composite implied market gains into Feb 16 and a consolidation thru early March (3/7). 2023 is following this pretty closely.
• This same composite now implies March to end of April will be the strongest 8 week period for 2023 with a median gain implied of 7%. If 2023 follows this path, the S&P 500 could reach 4,250-ish by the end of April. By the way, this lines up with the ~4,300 level in the coming weeks.
• I am not sure I agree with those who say the stock market is expensive. I think many cite this as another “confirmation bias” to stay on the sidelines.
• As highlighted earlier this week, ex-FAANG, the P/E (2024) of S&P 500 is 14.8X. And sectors like Energy are 10X and Financials 11X. These are not demanding valuations. And consider the fact that the US 10-yr at 4.0% yield is an implied P/E of a bond of 25X. Yup. The bond market is still far pricier than stocks.
  

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 Sunday). 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 (as of end of Feb) 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

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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