Investors remain broadly cautious on equities. This is completely understandable given the carnage in markets this year, along with the great uncertainties associated with the trifecta of rising inflation, Russia-Ukraine war and “negative shocks” delivered by Fed hawkish policy. But as a counterpoint, one can be constructive if one believes some combination of below:
- inflation proves to be less “sticky”
- economic resilience is better than feared (“growth scare” not recession)
- US economic dominance gained in 2022
- bad news is baked into equity valuations
- cash is on the sidelines
We have maintained a “2H rally” perspective as we basically believe all 5 of the above are true. And this is the central reason we remain positive on stocks, despite the Fed continuing to talk tough on inflation and the fact that Fed might be raising rates for an additional 6 months:
- Fed raising rates is not a binary impact on markets that stocks have to fall
- the key is whether Fed will negatively “shock” markets
- In 2021, bond markets were ahead of Fed in anticipating “rapid rate hikes”
- Since June 2022, bond markets are ahead of Fed in anticipating “getting to Neutral” far sooner
- 10-year at 2.7% is a 37X P/E for bonds, so should equity P/E really need to fall to 15?
Market internals suggest a “buy the dip” regime is back in force
One internal market measure often cited by Mark Newton, Head of Technical Strategy for Fundstrat, is the % stocks >20% off the 52-week highs:
- this measures what % of stocks are in a bear market (20% decline)
- this figure surged to 73% on 6/17
- and has since fallen to 52%, a big recovery
- at 52%, half of stocks are still in a bear market
- this is the worst figure since the March 2020 lows
In past 27 years, only 3 other times stocks this oversold
Since 1995, there are only 3 times stocks were ever this oversold as shown below.
- March 2003 lows
- March 2009 lows
- March 2020 lows
Hmmm… so it is evident that 73% is an extreme reading. That is, a lot of bad news is priced in.
BUY THE DIP: Any reading over 54% is the single best to “buy the dip”
Here is the reality. Whenever this figure is below 54%, this is the single best time to “buy the dip”
- bottom decile is when % stocks >20% off highs exceeds 53.9%
- Median forward 3M, 6M and 12M returns are 7.6%, 11.3% and 20%
- As above chart shows, this is the single best “decile” for forward returns
- read this as best time to employ “BUY THE DIP” regime
TECHNICALS: But stocks don’t go straight up, as Mark Newton sees S&P 500 4,200 as near-term top
But in the near term, buy the dip doesn’t mean stocks keep going up every day. As noted by Mark Newton, Head of Technical Strategy for Fundstrat, he sees stocks topping near S&P 500 4,200 before a retrace:
- generally, he sees first part of August weaker
- followed by a rally into mid-September
- near-term 4,200 (S&P 500)
- some sort of pullback above 3,850-3,875
- rally towards 4,400 by mid-September
- Reaching either 4,200 or 4,400 or would be a “shock” to investors
COUNTERTRADE: If S&P 500 reaches 4,200, sellside strategists might “lose their minds”
FYI, if S&P 500 reaches 4,200 and 4,400 in mid-September, the sellside might be scrambling.
- 60% of sellside strategists see S&P 500 ending at 4,300 or lower
- so you can see how risk/reward is dynamically becoming more attractive
- as interest rates stabilize, oil falls, stocks hold steady and economic data is supportive of falling inflation
JULY PAYROLLS: Could be stronger than consensus but driven by restaurants
Deep Macro, the macro independent research firm using alternative data, is calling for ~325k jobs compared to consensus estimates of 250k.
- the upside driver, in this work
- is restaurants which should show solid gains
- as proxies such as OpenTable data shows demand rose in July
Question:
- if upside in jobs is from restaurants
- will markets see this as so inflationary that Fed needs to be more “hawkish”?
- this is where the market’s reaction function could be changing
- while jobs could be seen as strong
- we know that wage pressures are easing and even job openings are slowing
- so merely looking at payrolls alone is misleading
And as noted by this chart by the FT shared by @carlquintanilla, consumption towards dining out has recovered sharply.
INFLATION: Corporate inflationary pressures might be easing, which means less inflation in pipeline
The path forward for inflation is unpredictable. So, we are aware that the timing of a turn in inflation is not yet known. However, keep an eye on leading indicators. For instance, this chart posted by @Lvieweconomics caught my eye:
- the Baltic Dry Index, which measures freight shipping costs
- has retraced the entire post-pandemic surge
- falling from 6,000 to 2,000, below where it was in 2019
- this might suggest that PCE goods inflation is set to fall far further
INFLATION: Even ISM Prices Index suggests PPI could be set to fall far further
And JPMorgan’s trading desk shared a chart (posted by @carlquintanilla) showing the steep 18 point drop in ISM Manufacturing Prices Index (proxy for prices) is arguably a leading indicator for a fall in PPI.
- these are more leading indicators suggesting inflationary pressures are set to ease
- the speed and magnitude is still not known
OIL: Newton sees $80s for oil, further easing inflationary pressures
Finally, a recent positive development for inflation is the possibility of a breakdown in oil. Mark Newton believes oil could fall to mid-$80s.
- a fall of this magnitude would further weaken gasoline prices
- energy inflation filters into so many parts of the economy
- a fall of this magnitude would further weaken inflation expectations
And as the chart below shows, a fall to the $80s would be a full round-trip in 2022. This is literally ZERO inflation:
- not inflation
- zero inflation
- future is uncertain
- prices could fall further if Russia-Ukraine war tensions ease
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
33 GRANNY SHOTS: Updated list is below
The revised 33 Granny shots is shown below. The list on the table below is sorted by the most attractive (most frequently cited) to least. To be a “Granny shot” the stock needs to appear on at least two portfolios:
- AAPL in 5 of 6 portfolios
- GOOGL MSFT in 4 of 6 portfolios
- AMZN META in at least 2
- This reinforces our favorable view of FANG in 2H2022
We publish on a 3-day a week schedule:
Monday
SKIP TUESDAY
Wednesday
SKIP THURSDAY
Friday
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33 Granny Shot Ideas: We performed our quarterly rebalance on 7/12. Full stock list here –> Click here
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