EPS: Less "bad" is good = inflection for fundamental equity investors = "buy the dip" returns. Week ahead light on macro data and still game of inches.

NEW: Notice new section (below): added so you can see our tactical ideas

In our view, last week added to the constructive case for stocks in 2023. The S&P 500 itself churned and remains in a range, fighting a “game of inches” but underneath this, we believe the arguments for stocks to gain in the remainder of 2023 strengthened.

• The gap between our relatively constructive view on stocks and the outright caution of our institutional investor clients is one of the largest we can recall. We have attempted to plot this on the chart below and overall point is obvious. There is no middle ground in markets today as opposing views are either “hard landing” (bears) or “soft or no landing” (ours). And at some point, there will be “tie breaker” data that will cause an abrupt shift in which view prevails.
• The assymetry we see is that positioning data shows the plurality, and arguably the vast majority of investors are already positioned for a “hard landing”:
  – FINRA margin debt saw a waterfall -35% decline in past year
  – since 1997, 3M% movements in margin highly correlated to stock moves
  – FINRA margin debt as % equity at 1.59% is the lowest since dot-com trough
  – data from Sentiment Trader shows small-investor shorts highest in 35 years
  – these are extreme negative positioning data points
• Forward EPS revisions (ex-Energy) might finally have bottomed, according to Goldman Sach’s Mark Flood (see tweet @carlquintanilla below). As Tom Luddy, former Vice Chair of JPMorgan Asset Management famously notes, “less bad is good” and fundamental investors often see the end of negative revisions as a key catalyst. This could turn many fundamental investors into “buy the dip” investors.
• That would be a massive change from 2022, when the downward and anticipated further downward revision cycle, turned many fundamental equity investors into “sell the rip” sellers. This would align with the extreme negative positioning as noted above.
• Of course, none of this will matter if the Fed continues to tighten monetary policy. The Fed “paused” after its May hike (5/3) and the April CPI (5/10) last week supported the rationale for a pause. Softer economic and inflation data would support “pause” and at the moment, this is a shaky equilibrium.
• I was somewhat encouraged by the April Atlanta Fed wage tracker (5/12) which showed “unsmoothed” wage growth fell to +5.1% YoY, the lowest figure since 2021. This would be supportive of the view that the SVB and regional bank crisis has delivered sufficient uncertainty and credit tightening to slow wage pressures. In fact, “job switchers” saw +6.9% YoY gains, the second lowest reading of the last 6 months. Granted, this is a “soft” data point but shows the labor market, while still strong, is cooling somewhat.

BOTTOM LINE: We still see higher probabilities of stocks >4,200 near-term rather than downside

As the first chart below shows, stocks have been in a very tight range between 4,100 and 4,150, essentially constituting a dull market. But this narrow range belies a sizable divergence in fundamental market views between “hard” and “soft” landing camps. Until tie breaker data emerges, market direction will continue to be like a “game of inches” (Al Pacino in Every Given Sunday, see YouTube below).

• We still favor a move higher near-term because of positioning. As noted above, the combination of FINRA deleveraging and small investor shorts, argues that positive fundamental surprise will drive a higher reaction function. Similarly, the upturn in EPS estimates could persuade fundamental investors to become dip buyers.
• Still favor FAANG as AI TINA: As for FAANG, we still believe these will be core outperformers in 2023. I am just leaving a conference in Istanbul and even here, there is wide discussion of the need for AI and automation. These tools are supplied by FAANG META1.40%  AMZN-0.99%  AAPL-0.57%  NFLX-4.18%  NVDA0.62%  GOOGL0.35%  MSFT-1.90% . Shouldn’t these rare stocks have a P/E premium?
• Industrials could benefit from stronger China data and ISM still tailwind: The regional ISM May survey Empire (5/15) and Philly Fed (5/18) will be important to Industrials. We believe ISM Manufacturing bottomed (April inflection) and if this momentum continues into May, this is a tailwind for Industrials XLI-0.33% . Additionally, economic momentum seems to be improving in Europe and Asia outside of China.
• REGIONAL BANKS “OUCH” BUT STICKING WITH IT: Of our recommended trades, the regional bank tactical rally has not yet materialized. But we are not at the give up stage yet. Regional banks arguably benefit from both a “pause” and from the bleed lower in interest rates. But the stocks are under selling pressure. Even today, JPMorgan CEO Jamie Dimon JPM0.68%  suggested on BloombergTV there should be a temporary ban on short-selling. I normally do not support such bans, but perhaps this is a case that makes sense, given the popularity of 0DTE options, etc.

US VS CONSENSUS VIEW: Last week’s data positive for forward returns, but still huge gap vs consensus

Below is a stylized graphic illustrating the difference between our constructive view on equity markets (still see ~4,750 by YE 2023) versus the persistently negative views held by the vast majority of our institutional investor clients:

• this is designed to show that despite relatively encouraging incoming data, there is still a sizable gap between our constructive view and the bearish consensus view (Fundstrat client consensus).
• As warranted, we will update the below chart but as it stands:
  – we see +14% upsideto equities in the next 12 months
  – many clients believe we will “re-test” the lows, which implies -15% downside
• The reasons for the yawing gap are multiple, but we highlight a few on the graphic below:
  – Debt ceiling risks are “binary” and impossible to normalize
  – fears regional bank contagion widens to a financial crisis
  – growing office vacancies threaten a CRE meltdown
  – EPS risks substantial given Fed tightening + regional banks
  – inflation remains sticky via prices and via wages
  – Fed is only “paused” and could easily start raising again
  – Russia-Ukraine war could easily become a larger conflict
• We have written extensively our counterpoints to the above, but the ultimate issue is that:
  – we believe inflation will prove to be far less sticky
  – solves many of the above issues
  – lots of bad news priced in by the -27% drawdown in 2022
  – 10-yr yields falling = supportive of equities
  – investor position is so negative, hard to cause further downside

EPS INFLECTION: Less “bad” is good = inflection for fundamental equity investors = “buy the dip” returns

Tom Luddy, former Vice Chair of JPMorgan Asset Management, used to famously say “less bad is good.”

• What he means is that when it comes to equity catalysts, when the trend becomes less bad, that is good.
• For S&P 500 EPS, when revisions reach their bottom, this is the “less bad” moment. As flagged by @carlquintanilla, Goldman Sachs’s Mark Flood, Structured Products, believes the worst of the EPS revisions cycle is behind us.
• If Flood is correct, we believe fundamental investors will turn more constructive on equities. And in turn, turn investors eventually into “dip buyers.”

POSITIONING: FINRA margin debt highly correlated to equity market

We highlighted how FINRA margin debt has collapsed since 2021 and went into a waterfall decline for much of 2022.

• some investors pushed back saying high margin interest rates is the reason for the decline
• we highlight the relationship between FINRA margin debt changes and S&P 500 returns.
• notice the sharp relationship? Whatever the driver, if FINRA margin debt starts to expand, this is positive for stocks
• and as we previously noted, FINRA margin debt as % equity is the lowest since dot-com, implying the figure is not likely to further shrink.

ECO: Atlanta Wage Tracker shows decline in expected wage growth = progress

The April Atlanta Fed Wage Tracker was released last Friday (5/12) and there was a surprising drop in the reported wage growth:

• the “non-smoothed” April data showed +5.1% growth YoY
• this is the lowest reading since 2021 (below) and a huge reversal of trend of 2023, where the “unsmoothed” figure was above the prevailing trend — meaning, upward pressure until April.
• is this a sign of a cooling labor market?
• if so, this would be one of many showing the red hot jobs market is coming off the boil, to an extent. And this would be helpful for reducing inflationary pressures.

And even the “smoothed” data is showing wage pressures generally easing:

• jobs switchers YoY expected wages is the second lowest in the past 6 months
• that would signal that demand for lateral moves is ebbing
• and it is the “job switchers” that have driven wage pressures.
• as shown below, “job stayers” generally get lower wage increases.

ECO: Generally light week ahead…

There are many incoming economic reports this week, but few will likely be as market moving as inflationary reports. As shown below, the highlights are:

• May Regional ISM surveys due (Empire 5/15 8:30am ET, Philly Fed 5/18 8:30am ET)
• April Retail Sales (5/16 8:30am ET)
• Housing data (5/16 10:00am ET May NAHB Index, 5/17 8:30 April Housing starts, 5/18 10am ET April Existing Home Sales)

ECONOMIC CALENDAR: Key May data is inflation and ISM, and April was overall “tame”

Key incoming data May

• 5/1 10am ET April ISM Manufacturing (PMIs turn up)Positive inflection
• 5/2 10am ET Mar JOLTSSofter than consensus
• 5/3 10am ET April ISM ServicesTame
• 5/3 2pm Fed May FOMC rates decisionDovish
• 5/5 8:30am ET April Jobs reportTame
• 5/5 Manheim Used Vehicle Value Index AprilTame
• 5/8 2pm ET April 2023 Senior Loan Officer Opinion SurveyBetter than feared
• 5/10 8:30am ET April CPITame
• 5/11 8:30am ET April PPITame
• 5/12 10am ET U. Mich. April prelim 1-yr inflation Tame
• 5/12 Atlanta Fed Wage Tracker April Tame
• 5/24 2pm ET May FOMC minutes
• 5/26 8:30am ET PCE April
• 5/26 10am ET U. Mich. April final 1-yr inflation
• 5/30 Conference Board Consumer Confidence

Key data April

• 4/3 10am ISM Manufacturing Employment/Prices Paid MarchTame
• 4/4 10am ET JOLTS Job Openings (Feb)Tame
• 4/7 8:30am ET March employment reportTame
• 4/12 8:30am ET CPI MarchTame
• 4/12 2pm ET March FOMC MinutesTame
• 4/13 8:30am ET PPI March Tame
• 4/14 7am ET 1Q 2023 Earnings Season Begins Better than feared
• 4/14 Atlanta Fed Wage Tracker MarchSemi-strong
• 4/14 10am ET U. Mich. March prelim 1-yr inflationHawkish
• 4/19 2:30pm ET Fed releases Beige BookTame
• 4/28 8:30am 1Q23 Employment Cost IndexSemi-strong
• 4/28 8:30am ET PCE MarchTame
• 4/28 10am ET UMich April final 1-yr inflationHawkish

POSITIONING: FINRA Margin debt shows positioning is far more bearish than most appreciate

One might think that this doesn’t mean stocks need to rise, even if the data has moved towards the “soft landing” camp. But keep in mind, investors have de-risked and de-levered to a significant extent. We covered much of this recently including the massive swing to short S&P 500 futures contracts and the surge in ICI retail cash balances.

Today, we want to highlight the collapse in FINRA margin debt. The latest figure shows margin debt is now $607 billion:

• this is down -35% since late 2021 and a decline of $330 billion from peak
• during GFC, the FINRA deleverage was $216 billion, so already surpassed
• margin debt as % market cap now 1.59%, matching “dot-com” 2002 25-year low

• In other words, while this might be a marginal positive shift on fundamentals, there is a far greater positioning shift ahead, if the data ends up proving to be “soft landing”

This time series really shows the extent of de-leveraging. The level of margin debt to market cap is at 1.59% and same as dot-com trough

• so any decisive “soft landing” data will shift positioning far more dramatically

SMALL INVESTOR POSITIONING: Even small investors are ultra-bearishly positioned

As Sentiment Trader’s Jay Kaeppel highlights, there is a significant increase in small-speculator short positioning:

• notably, this figure is the most short since the series began in 1990
• think about that, a 35-year high in shorts by small investors
• again, highlighting how lopsided the positioning is currently

STRATEGY: Focus on Industrials, a week to make a tactical positive bet

Both the ISM PMI and S&P Global US PMIs are released on Monday:

ISM Manufacturing PMI has been better than consensus.

• Actual 47.1 vs Street 46.8 and last month 46.3

S&P Global US PMIs has come in slightly lower than consensus, but remains above 50.

• Actual 50.2 vs Street 50.4 and last month 50.4

Whenever PMIs bottom (see below), Industrials tend to bottom. This first chart shows rolling change for US PMIs and US Industrials returns.

This distribution table puts this in a clearer light. When PMIs are rising and from low levels, Industrials see strong gains.

• Since 1948, when PMIs are over 50 and are rising (n=60), Industrials see positive forward 6M and 12M gains of 85%/95% of the time with median gains of +12.6%/21.5%, respectively.

• Those are very favorable risk/reward and high absolute return opportunities.

Industrials are oversold vs S&P 500 on 20D %-change, with a z-score of -1.2.

• The top chart is the relative price ratio of Industrials vs S&P 500
• The bottom is the z-score of the 20D % change.
• The most recent 4 times this was seen, Industrials staged strong rallies vs the broader market.

• This is not that different than the signal we highlighted two weeks ago regarding FAANG/Technology. And we know that FAANG powered higher in the past two weeks

And Industrials are the most oversold vs other sectors, particularly against Staples.

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