China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

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WEBINAR ALERT: 5/19 at 2pm ET for FSinsight Members

We are delighted to announce we are hosting a webinar with Tom DeMark, founder of DeMark Analytics.

  • Equities have been in a relentless downturn since the start of 2022.
  • While valuations have become considerably more attractive, and sentiment rock bottom, investors are still hesitant to add risk until there are clearer signs the “worst is priced in”
  • Tom DeMark and his DeMark indicators are exceptionally valuable tools in identifying these turning points
  • Recall, Tom DeMark indicators called the precise bottom for stocks in March 2022

The link to register for this webinar is —> HERE

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Shanghai to exit mass lockdown = first step in removing overhang

China announced that physical stores will reopen in phases in Shanghai, as community transmission has slowed sufficiently. After more than 60 days of mass lockdowns, this is welcome news for the global economy. While the extent of the economic damage from this is not entirely clear, this removes one of the major overhangs for the economy and markets.

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
Source: https://twitter.com/business/status/1525795546266574849?s=12&t=nZQ_sYGaloXqi5UiAvYdZw

Case trends in Shanghai have vastly improved as cases are down 90% from their recent peak of 25,000 (7D avg) in April 2022.

  • It took about 30 days for cases in Shanghai from parabolic start to peak
  • This is in line with Omicron surges seen in other nations
  • The lockdown in Shanghai has been in place for 60 days
  • Beijing is still facing mass restrictions and cases might be peaking there at 51 — yup, 51
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

10X: China 2022 lockdown affected 160 million citizens versus 2020 Wuhan 13 million

If you are wondering if China lockdowns in 2022 are consequential, consider this — according to Xu Jianguo:

  • the 2022 lockdowns impacted 160 million Chinese citizens
  • this is an estimated 18 trillion yuan ($2.7T USD)
  • the 2020 Wuhan lockdowns impacted 13 million

So these are far greater in scale.

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
Source: https://www.scmp.com/economy/china-economy/article/3177190/coronavirus-economic-toll-chinas-latest-outbreak-10-times

China cutting mortgage rates = policy easing

The PBOC (China’s central bank) cut the mortgage rate for first time homebuyers to 4.4% from 4.6%, in a significant move to boost the housing market. On balance, this is a positive. Other central banks stimulating while Fed hikes is not necessarily cross currents, since the Fed is trying to contain US inflationary pressures by surpressing demand in the US.

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
Source: https://www.bloomberg.com/news/articles/2022-05-15/shanghai-adds-1-369-local-covid-cases-zero-outside-quarantine?cmpid=socialflow-twitter-business&utm_medium=social&utm_campaign=socialflow-organic&utm_source=twitter&utm_content=business&sref=NVS0rEaE

China equity market bottomed at the end of April and outperforming YTD

One of the strongest arguments for being “half-full” on China is the fact that China stocks have begun to outperform global equities (MSCI ACWI). As shown below:

  • China’s Shanghai composite (SHCOMP) bottomed at the end of April
  • YTD, the SHCOMP is outperforming the MSCI All-world Index
  • This is a sign financial markets believe the worst might be behind
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

In the US, signs of easing in demand, which in turn could ease price, continue to appear

Over the past few days, there are also signs that inflationary pressures might be easing — on the margin, and this is still incrementally positive. The Fed’s primary concern is containing inflationary pressures in the US. There is growing evidence that inflation, as measured by either CPI or core PCE (personal consumption expenditures) is peaking. But peaking is not necessarily the same as declining. So accumulating data points supporting further easing will ease market anxiety.

  • Adobe (below) reported US domestic flight bookings fell 17% in April (month over month)
  • this is only a modest green shoot, since demand still remains strong
  • but it’s an anecdote
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
Source: https://www.businessinsider.com/domestic-flight-bookings-fell-17-in-april-as-fares-continue-to-rise-2022-5

Goods inflation led by used + new cars, while eased mildly in April, but further weakness is key

Similarly, used car prices have been a major component of CPI. The WSJ.com below made an interesting point:

  • April is normally a seasonally strong month for car demand
  • Americans receive their tax refund
  • But used car prices, seasonally adjusted, actually fell in April
  • Potentially, this might suggest that true demand might be weaker (excluding the impact of tax refunds)
  • So, May will be instructive… but that is a month away
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
Source: https://www.wsj.com/articles/used-car-buyers-are-seeing-relief-on-once-soaring-prices-11652529601

…Still, Carvana and other used car equities suggest much greater weakness in used car prices ahead

If one of wondering what the equities of used car dealers is saying, these equities arguably say further weakness is ahead. Look at the YTD relative returns:

  •  CVNA -2.57%   VRM and  SFT, all used car dealers have been falling sharply since Sept 2021
  • the industry is cyclical and capital intensive and while multiple factors explain the decline in price
  • at the core, used car economics are not as attractive
  • with falling stock prices, and capital being raised, this sounds like an industry that will increase competitive pressures going forward
  • this argues that further declines in car prices lies ahead
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

STRATEGY: The S&P 500 has priced in 100% chance of a recession

When I worked at Kidder Peabody, some equity people called a broken stock a “Missouri stock” — that is, the stock has fallen so much, it has become a “show me” stock. Get it? Missouri?

  • The S&P 500 broke below its 2/24 Russian invasion low of 4,114 in early May
  • and fell swiftly another 300 points
  • before staging a minor reversal

While it is blindingly evident that investors are bearish and positions are light. And valuations are not demanding. And there is evidence that two major headwinds for stocks is easing — inflationary pressures and the China lockdown.

  • our base case remains that equity risk/reward is far better than consensus believes
  • as we believe incoming data will support inflationary pressures will ease
  • and a lot of bad news is priced in
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

How much bad news is priced in? A 20% decline peak to trough is a recession, not a growth scare

Equities were down ~20% peak to trough earlier in May. This is similar to the 2018 decline in stocks and at that time, the markets had priced in a “growth scare” or something worse than a slowdown, but not an outright recession. There are many investors who think more downside is ahead for equities, as the “growth scare” in 2022 still has months to play out.

That is still a possibility, but there are arguably some things that could pivot positively. Granted, that has not yet happened decisively, but it could in coming weeks/months:

  • economic-driven inflation pressures ease faster than expected (possible)
  • interest rates to drift lower (possible)
  • Russia-Ukraine war approaches “beginning of end” (possible)
  • But the most significant, but unlikely, is Fed reverses course (less likely) as inflationary pressures or job market cools

So a few things could go right.

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

STRATEGY: Gut punch past week puts S&P 500 into waterfall seen only 18 times since 1940

During the week, stocks were down 5% for the week and had declined 16% in the past 5 months:

  • declining 16% in 5 months is a waterfall collapse
  • this pace was seen only 18 times since 1940
  • waterfall declines show investors are now liquidating stocks without a focus on price
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

In 9 of the 13 most recent instances, S&P 500 often near end of decline when a 16% waterfall decline seen

Take a look below at the instances of 16% declines in 5 months — there are 13 since 1970. And we mark the levels of the S&P 500:

  • Of the 9 of the 13 instances shown, S&P 500 was near the bottom
  • key exceptions was 2001 (twice) and 2008 (twice)
  • But instances like 2011 and 2018, both soft landings, show markets bottom on the waterfall decline

This might be the key point. What is the US economy facing?

  • if it is a “hard landing” then markets are facing lots of trouble
  • if this is a “soft landing” then the bulk of the bad news is priced in
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

The fuller 18 instances is shown below and highlights there is a positive risk/reward:

  • 13 of 18 instances, stocks higher 12M later
  • median gain is 14%
  • looking over the instances, the key question is really whether this is a soft landing or a hard landing
  • hard landing being 2000-2002 and 2008-2009
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

Market is not valuing stocks based on fundamental outlook…

As shown below, stocks are no longer trading at fundamental valuations relative to growth rates. As shown by the “slope” of the line on the right:

  • faster growing companies are trading a lower FCF valuations
  • negative revenue growth cos have a higher FCF valuation
  • this suggests markets are selling what they can sell
China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

According to RenMac, correlations for Russell 1000 stocks is now 0.59, which is highest decile

The RenMac tweet below caught my eye. He notes that rolling correlation hit 59%

  • when correlation between stocks in an index rise, this means selling is indiscriminate
  • correlation of 59% is top decile
  • their analysis (since 1979) shows 3M returns are very strong at top decile
  • median gain is 7% next 3 months
  • this is well above the 3.75% across all periods

This further supports the notion that investors are in the “get me out of everything” mode. This is a reason investors should not be throwing in the towel.

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks
Source: Twitter

STRATEGY: Cost of capital has risen, hurting unprofitable companies, but large-cap tech is oversold

With equities in a tailspin, the natural question is whether stocks need to keep falling given the cost of capital is rising (10-year yields higher). We published the chart below previously and it shows P/E and 10-year yields. And as shown below

  • in the 20-years from 1990 to 2019, the 10-year averaged 5.3% and P/E averaged 17.7X
  • interest rates averaged 2.1% in the past 12 years, but the P/E averaged 17.3X
  • counter to what many believe, the overall market P/E does not have to de-rate

But of course, a rise in interest rates is raising the cost of capital. And companies with low ROIC, or low-return businesses will lose access to capital. Today, that is:

  • unprofitable companies
  • companies with high P/E that rely on future years for earnings justification
  • many start-ups

Collectively, this is where weakness will emerge. FYI, many start-ups are in retail. And with this area losing funding, the 1.34 million hires in the past 30 months could see losses. Earlier this week, we published an estimate that ~4 million Americans are employed by venture-backed companies.

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

Technology has de-rated and trades at the same multiple as Staples

And as investors have become extremely defensive, we are seeing this in the convergence of the P/E multiples of Technology and Staples as shown below. The question is whether this is fair value.

  • if the economy is facing a hard landing, Staples can rerate higher
  • if this is a growth scare, Technology will again rerate higher

We are in the camp that this is a growth scare.

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks


STRATEGY: We lean relatively “bullish” into 2H2022 (but also 2Q22), but warn of jagged next few months… Stick with BEEF
To recap on equity strategy, we are leaning bullish into 2Q2022.

Stocks have continued to be treacherous in 2022. Investors are on a hair trigger.

– this is in context to a challenging 1H2022
– so jagged next 3 months

Broadly, our existing sector strategy of BEEF remains valid. Even in war. Even with inflation. In fact, the last few weeks are strengthening the case for our “BEEF” strategy. That is, BEEF is

– Bitcoin + Bitcoin Equities  BITO 3.26%   GBTC 3.22%   BITW -2.74%
– Energy
– FAANG  FNGS -0.16%   QQQ -0.21%

Combined, it can be shortened to BEEF.

Why is this making stronger BEEF?

– Energy supply is now a sovereign priority
– this helps Energy stocks

– Ukraine and Russia both want access to alternative currencies
– this strengthens case for Bitcoin and bitcoin equities

– if Global economy slows, growth stocks lead
– hence, FANG starts to lead  FB  AAPL -1.12%   AMZN 0.19%   NFLX -1.10%   GOOG 0.21%

All in all, one wants to be Overweight BEEF

China ending Shanghai lockdowns sigh of relief and further alleviating downside pressure on stocks

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31 Granny Shot Ideas: We performed our quarterly rebalance on 4/5. Full stock list here –> Click here

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