The Fed’s September FOMC meets this week and a rate decision will be made on 9/21. Last week, equities suffered the largest weekly loss in 2H2022 so far, falling 4.8% (4th worst week of 2022) on the heels of the August CPI.
- consensus is looking for +75bp
- futures markets pricing in roughly 1 in 4 chance of 100bp
- as Goldman Sachs economists note, there are a few reasons the Fed could lean more hawkish vs prior
The summary of their FOMC preview is below and the rationale for +75bp (slightly higher vs post-July FOMC):
- equities are up (although higher equities are not underlying drivers of recent inflation pickup)
- labor markets strong enough to handle “aggressive tightening”
- Fed losing patience and want faster progress
- possibly re-evaluating “neutral rate”
A lot of bad news has been priced in the last 4 weeks. Take a look at the weekly S&P 500 chart below:
- the downturn in equities in the past 4 weeks stem from Powell’s speech at Jackson Hole and the August CPI (last week)
- prior to these events, equities were making far steadier progress in 2H2022
Markets not likely to be “negatively” shocked by +75bp, but risk is if Fed decides terminal rate higher than 4.5%
The current consensus forecasts for Fed Funds is shown below and as we highlight:
- +75bp in September
- +50-75bp in November
- +25bp in December
So, from a market view, a few things stand out:
- Last big hike is September or November
- Modest hikes going forward and 4.5%-ish terminal rate
- The worst of the hikes is this Sept meeting or November
- If this or November are the worst of the hikes,
- shouldn’t markets start to see “the beginning of the end”?
I guess this is more a question aloud. But if this meeting or November is the last of the major “hawkish” super-sized hikes, I just wonder how much further downside “shocks” lay ahead.
ANOTHER RECORD: S&P 500 sell-off post August CPI is one of the 10 worst 5-day sell-offs post-CPI
The S&P 500 sell-off post-August CPI of -5%-ish is one of the 10 worst market reactions to CPI since 1970.
- the 10 worst reactions are highlighted on the price chart below
- notice something somewhat curious?
- stocks seem to do pretty well going forward
This is difficult to tell if there is a causality issue. That is:
- what if these CPI reports simply got reported at a time when S&P 500 was about to inflect higher?
- this is possible, but what is curious is this is based upon 5-day market reaction
- and it does seem like a strange coincidence that markets seem to bottom around bad CPI prints
- after all, CPI is only reported every 30 days
The list of the 10 worst market reactions are below:
- 2 of the 10 are in 2022 (June 2022, post-May CPI)
- 2 of the 10 were back to back in 1974
- and as we higlighted previously, that coincided with a local top in headline CPI
The 1974 CPI context is shown below. Those two reports coincided with an inflation peak by late-1974.
- so it is important to keep the August CPI context in mind
- a lot of bad news was priced in last week
INFLATION DATA: Plenty of data in the next 3 weeks
We have listed the key incoming inflation data points over the next two weeks (through 9/30) and as shown, there is plenty of data.
- this week, FOMC
- next week, Case-Shiller, Conference Board, regional PMIs
- August PCE (Fed’s preferred) and U Mich. consumer inflation expectations
INFLATION: Next 3 weeks will see lots of incoming data points around inflation trends…
AUGUST CPI: Goods inflation surprisingly strong, including autos and apparel and home furnishings
While August CPI was certainly a negative surprise, the report was not entirely negative. I found the comments from GS Economists helpful:
- core inflation is too high and as many economists noted
- wage-sensitive and some sticky components seeing higher inflation
- higher inflation seen even in goods
- but the forward looking measures like PMIs, wage-trackers, etc show inflation cooling
FUTURE CPI: Futures market still sees Fed Funds peak April 2023, Inflation ~2.5% by June 2023
Even looking post-CPI, inflation futures still see inflation falling into 2023. While the “level” of inflation for each month crept up, the message is the same:
- inflation peak is still looking like June 2022
- Fed Funds peak still looking like April 2023
- Inflation could fall to 2.5%-ish by June 2023
- this is still encouraging, all things considered
SILVER LININGS: August CPI curiously showed apparel and home furnishing and autos accelerated in August
Lastly, while the overall message of the August CPI was a negative, it is not entirely all bad news:
- 47% of components are “deflating” from their 18 month peak, up from 42% in July
- “goods” CPI was an upside surprise which was led by 3 categories
- Autos, Apparel and Home furnishings
- In fact, these 3 categories were a top 5 contributor in each of the regional CPIs
The fact that Goods CPI was +0.5% in August is a surprise. After all, goods are impacted by:
- supply chains
- commodity costs
- fuel costs
- PMIs show pricing easing
All of which have turned lower, so that fact the monthly increase rose:
- July +0.2%
- August +0.5%
- surge in “goods” CPI
Auto CPI jumped significantly in August.. 14% of CPI and the largest sequential acceleration
As highlighted below, Auto CPI jumped significantly:
- Auto goods +0.4% from +0.1% in July
- Auto services +0.5% from -0.5% in July
- these are among the largest sequential changes in inflation among major categories
The total weight of autos is 14% of CPI, so its a big deal. Below, the categories for goods and services is shown.
USER CAR CPI: Manhein down 11% YTD while CPI used cars flat
Look at the differential between used cars price index (Manheim) and the CPI used car index:
- Manheim down 11% YTD
- Used car CPI down 1.5%
- as shown, Manheim leads CPI by 1-3 months
- so a “bigger decline” in used cars should be in the pipeline
- that is a silver lining
GOODS CPI: Why is household furnishing and apparel accelerating?
Another goods CPI curiousity is home goods and apparel:
- household furnishing +1.1% vs +0.6% in July
- that is a doubling of 12% annualized inflation. Why?
- Apparel surged to +0.2% from -0.1% in July
- with all these retailers cutting prices and with bloated inventory… why?
REGIONAL CPI: Surges driven by autos, apparel, household furnishing and housing
Curiously, the regional CPI show this same pattern.
- the top 3 regions that saw a rise in sequential rates (monthly % change vs rate prior)
- these are New England, Mid-Atlanic and West South Central
REGIONAL CPI: Look at top 4 accelerators…
In New England, look at top 4 contributors to the acceleration
- Furnishings
- Food at home
- Shelter
- Apparel
Whoa. Apparel and Furnishings?
In Mid-Atlantic, look at the top 4:
- Fuel and utilities
- Used cars/ autos
- Apparel
- Shelter
- Why autos and apparel?
Look at West South Central:
- Used cars/autos
- Shelter
- Apparel
- Food away from home
- why autos and apparel?
See the pattern? I am confused how apparel was a top contributor to CPI
STRATEGY: STRUCTURAL CAPITULATION: Since 1996, 13 prior instances of “0” Nasdaq advancers and only 6 when Nasdaq already down 25%
Since 1996, there have been 13 such prior instances where the Nasdaq 100 went completely “no bid”
- these are plotted as dots below
- the yellow are instances of zero advancers
- the red are instances of zero advancers and when Nasdaq is already down 25% from an 18-month high
ZERO BID: 13 of 13 times, Nasdaq 100 higher median 12M gain 21%. When already >25% drawdown, median gain +64%
The forward returns for the Nasdaq post-zero bid are impressive:
- 13 instances, median 12M gain is 21%
- 100% win ratio, or 13 of 13 instances
- when drawdown >25% in place, median 12M gain is +64%
- staggering upside
This highlights that the Nasdaq has structurally bottomed. That is, when zero stocks advance, that is essentially one form of capitulation.
The scatter below highlights that the stronger the drawdown in place (x-axis), the greater the 12M upside.
- the shaded red area are instances where Nasdaq drawdown was already >25%
- the intercept of this regression implies Nasdaq 100 could have >40% upside in the next 12M
STRATEGY: 2H rally view intact
Given the list of market worries above, the natural question is how is there a positive thesis on equities into 2H2022? Here is our take:
- our continuing analysis shows leading indicators point to disinflationary/deflation
- US corporates remain impressively resilient, enduring the pandemic global shutdown with cost discipline
- and US corporates are weathering the inflation surge impressively as well
- the US economy has managed to absorb rapid Fed rate hikes so far
- and US economic relative positioning far stronger in 2022
- US net beneficiary of higher energy prices, absolute and relative (US exports oil)
- US is on-shoring assets = future competitive advantage
- US has labor issues, but this will be solved by either automation or rise in workforce participation
- investor sentiment is rock bottom and worse than GFC by some metrics
- fixed income markets show far less inflation in swaps, etc
- and while many believe “bonds are getting it wrong” including Fed officials
- the drop in energy and housing and other indicators are supportive of this lower inflation outlook
- hence, Fed could do far less tightening as the market is doing Fed’s work
Bottom line. We see 2H rally thesis intact.
STRATEGY: 2022 Bear market was 164 days, or 25% duration of prior bull
Our data science team put together the comparative duration of bull markets and bear markets, and the corresponding ratio:
- since 1942, there have been 14 such cycles
- median ratio of bear vs bull is 31%, meaning a bear market is roughly 1/3 duration
- since 1982, this ratio is only 15%
- in 2022, the preceding bull market was 651 days
- the current bear market was 164 (using 6/16)
- or 25% ratio
As seen below, this ratio is solidly within the ranges seen since 1982.
- many investors think “more time” is needed for this bear market
- but given the shortness of the preceding bull market 651 days versus 1,309 median
- the corresponding bear market should also be shorter
BUY THE DIP REGIME: Stocks already saw fundamental capitulation
And we want to revisit the chart below, which looks at the internals of the S&P 500 — the % stocks >20% off their highs, aka % stocks in a bear market.
- this figure surged to 73% on 6/17
- this was only exceeded 3 times in the past 30 years
- each of the 3 prior instances was the market bottom
- we think this is the 4th instance
BUY THE DIP: forward returns strong
And stocks have the best forward returns when this figure exceeds 54% as shown below:
- in 3M, 6M and 12M
- the best decile for returns
- is when this figure is oversold >54%
- hence, buy the dip regime is in force
We publish on a 3-day a week schedule:
Monday
SKIP TUESDAY
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SKIP THURSDAY
Friday
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