I just returned from a multiday visit with institutional investors in Tel Aviv. Over the course of two days, we sat down with over 80 institutional investors representing AUM of >$500 billion. We spent half a day in Jerusalem (my first visit there) and in that short time, managed to see the Wailing Wall, Dome of the Rock and Church of the Holy Sepulcher.
Similar to the plurality of our institutional investor meetings in the US, investors are overall quite cautious. And the following are the drivers:
- Inflation is the primary concern. The starting point is many cite the high level on YoY as headline of +7.7% (Oct) and Core +6.3% as alarming. And the Fed funds of 4.0% woefully low when looking at these inflation rates. Additionally, many did not quite understand the market’s enthusiasm over a better than expected Oct CPI as many saw risks for inflation to continue accelerating.
- Investors are taking the Fed and FOMC at face value. Meaning, investors are expecting the Fed to raise at least +50bp in Dec (some think +75bp) and increases thereafter as many expect the FF terminal rate to be something higher than the “dot plots” of 4.6%.
- On earnings, many are skeptical of consensus 2023 EPS of $233 (+5% YoY) and many expect earnings to be down -10% to -20% in 2023 given an anticipated recession. A recession is the central case for most clients and many point to the inversion of the “nominal” yield curve as the reason for this.
- Investors believe opportunities could be more attractive in Europe or China as these markets have suffered more than the US in 2022. And this remains path dependent to an extent. For Europe, if the Russia-Ukraine war is resolved, Europe will see disproportionate gains. On China, ending zero-COVID would be a catalyst. But both end of war and zero-covid would benefit US equities as well.
- Several major Wall Street banks have been through Tel Aviv in the past few weeks, and clients told us the message from these banks is overwhelmingly bearish. The message contained a variation of: inflation remains too high, Fed will break something and EPS will fall 20% or more.
- As for sectors, investors are mostly defensively positioned. Healthcare is a consensus overweight. Investors are underweight Technology and cyclicals.
Taking a step back, at the heart of the cautiousness is uncertainty about the trajectory of inflation. And how monetary policy evolves around the path of inflation.
2023 EPS: Fundstrat’s Quant and Portfolio Strategy team see 0-5% EPS growth in 2023
The bottom line question for investors is what will 2023 EPS look like. Our macro team has the following views:
- Brian Rauscher (BR) –> estimates are in the process of falling and this could bottom in 1H2023
- BR –> but 2023 EPS ultimately settles at something like mid-single digits EPS growth
- Adam Gould (AG) –> margin and sales estimates are too high and his proprietary models see downside vs 2022 trends
- AG –> 2023 EPS growth is 0-5% and EPS of ~$230-ish
- USD rose +18% in 2022, and this has subtracted 5% to 8% from 2022 EPS
So 2023 EPS is not expected to be a total disaster. The estimates for BR and AG are lower than Street consensus:
- Bottoms-up using Thomson Reuters/Eikon
- $233 EPS and +5% EPS growth
- But if USD falls 5% to 10% in 2023 (Mark Newton sees as possible)
- this would add 3% to 5% to 2023 EPS on top of consensus of $233
FED: Fed looks at forward looking measure of inflation, not just current CPI YoY
We think too many investors take trailing CPI YoY and compare that to current Fed funds.
- and by doing this, says Fed needs to push rates to 6% to 7% or more
- but as Powell even notes, “you’d look more at a forward, a forward-looking measure of inflation”
- and if core CPI MoM runs at 0.2% to 0.3% for next few months, that is annualized inflation of 2.5% to 3.5%
- Fed funds of >4.5% is quite restrictive
And if Fed raises +50bp in December (expectations), this means Fed Funds and the 2Y yield would be at the same level.
- Markets look at the 2Y yield as the measure “where the Fed needs to get to”
- This is currently 4.46% while midpoint of Fed funds is 3.88%
- After December, assuming +50bp, midpoint of Fed funds would be +4.38%
- The spread would be essentially zero
- Unless 2Y yields push higher, the market is essentially saying Fed “pause” coming
- and if inflation is not strengthening, there may be no more hikes
In fact, this is generally where Fed starts to pause as shown below.
CPI: The softer than expected October inflation is repeatable, in our view
We had the most discussion around inflation in these meetings. We believe core inflation month-over-month will likely be soft over the next few months, as the factors behind the soft October (+0.27) are repeatable as highlighted below:
- Shelter/OER is starting to grow at a slower pace and the “market-based measures” like zillow rent, etc show this to be far weaker
- Healthcare will be softer as the volatile Healthcare Insurance flips negative
- Cars are rolling over
- Apparel and durables rolling over
This is highlighted below
Even Food CPI is set to rollover.
- The FAO (of UN) Food Price Index has been negative for 7 consecutive months
- YoY is now down to +2% from +40% in 2021, a massive deceleration
- FAO leads food CPI by 7 months and implies Food CPI is set to slow dramatically from +11% to +2% in coming months
Economists see PCE <3% before YE 2023
Goldman Sachs in this past week also reiterated their view inflation is set to fall in coming months. They “expect a significant decline in inflation next year”:
- “core PCE measure falling from +5.1% currently to 2.9% by December 2023”
- this is a massive drop in inflation rates
Medical Insurance set to fall -40%
On Medical Insurance, we have written previously about this annual adjustment. But as shown below, this is set to fall -40% over next 12 months. This has to do with how this CPI item is based upon the profit growth of the Healthcare industry and thus, in 2021, insurers profit fell -40% and that is applied to 2023. This is due to a jump in doctor visits in 2021 and the somewhat peculiar process of applying this to the following year’s CPI insurance.
November Manheim mid-month shows further decline in used car prices to -14%
Manheim continues to tank. The YoY is now -14%
- this is creating a huge gap
- Used car CPI is still +2%
- Manheim is -14%
- This 17% gap is future deflation
STRATEGY: Put-call ratio hits 1.46… contrarian as it shows consensus still bearish
This tweet by Helene Meisler caught my eye. The CBOE Equity Put-call ratio hit 1.46 which is a staggeringly high figure:
- this shows investors are buying put protection and see downside to markets
- this was registered on 11/16 (Wed)
- this figure exceeds to March 2020 peak of 1.30
- this is considered a contrarian buy signal as it shows investors are betting on downside
- thus, positive news could cause a reversal in equities higher
For added perspective, our team highlighted the 5 highest equity put-call readings since 1997 along with S&P 500 forward returns. The top 5 are:
- 10/8/2001: 1.52 (6M Fwd Return: 5.7%)
- 2/13/1997: 1.47 (6M Fwd Return: 14.1%)
- 11/16/2022: 1.46 (6M Fwd Return: ?)
- 3/17/2008: 1.35 (6M Fwd Return: -2.0%)
- 3/28/2003: 1.32 (6M Fwd Return: 16.9%)
- 3/12/2020: 1.28 (6M Fwd Return: 34.3%)
Lastly, keep in mind the positive seasonals in YE. We highlight market returns (since 1987) based upon sentiment.
- when sentiment is the most negative (see red line, ex-2008)
- stocks perform strongly into YE
- this is roughly 7-10% upside from here
Please don’t ignore the 6 key signals from last week
Most of 2022 has been a cascade of ever more troubling developments, from surging inflation, Russia-Ukraine war, Fed going full Volcker, China issues and multiple seismic crypto events (terra luna, 3 Arrows, Voyager Digital, and now FTX). And this has pushed interest rates higher, panicked policymakers and punished equities. Still, equities found some sort of footing on 10/13 (day of Sept CPI) and since risen 15%.
Last week was a “game changer” in our view, principally due to the far softer and repeatable Oct CPI but there were 6 signals generated last week. Each of these 6 are why we see a far different path forward for markets:
- Foremost is the positive Oct soft CPI (and repeatable) which showed a favorable break in 3 key inflationary areas: shelter/OER, medical care and goods (apparel and used cars). We expect this to be sufficient for Fed to slow pace of hikes, and possibly December 2022 may be the last hike.
- Second, bond volatility is collapsing (VXTLT or MOVE -0.20% ) and this is a point made repeatedly by one of macro clients (HA in NYC, who works at a major pod of macro HF). Similarly, Tony Pasquariello of Goldman Sachs notes bond volatility “is one asset that every other asset is priced off.” For perspective, TLT Vol (VXTLT) lows has marked every equity market high in 2022. The 8/12 low of 17 marked S&P 500 highs of 4,300.
- VXTLT has plunged from 33 to 21 in less than 15 sessions and we expect to fall to 15 or so. This collapse in volatility, in our view, would support S&P 500 surging to 4,400-4,500 before YE.
- Third, US yields saw a massive decline ranking in the bottom 1% largest downside moves in the past 50-years. Analysis by our data scientist, Matt Cerminaro, shows yield declines of this magnitude portend further declines in rates 6M and 12M forward. In other words, chances are rising the highs for the 2Y and 10Y yield are in further supportive of P/E multiple expansion.
- Fourth, USD (DXY) posted one its largest ever declines (6D) falling -5.8%, ranking it the 8th largest ever decline since 1970. As our data science team shows, USD historically lower 6M and 12M later. Increasingly looks like the top is in for USD as well. Several FX strategists are making similar comments including Deutsche Bank’s George Saravelos.
- Fifth, there is economic signal in the fact that Republicans fared poorly in 2022 midterm elections. While preliminary, it looks like Democrats will hold a majority in the Senate and Republicans have only a slim margin in the House. While many politicos call this an indictment of Trump, we think the bigger message is the economy is simply not bad enough for voters to kick out the Democrats. Inflation arguably is not bad enough that voters are blaming incumbents. Think about that. If inflation is “as bad as 1980s” I would have thought midterms would have been an incumbent massacre.
- Sixth, crypto had one of the tsunami of financial collapses ever (largest in dollar terms), with liquidations (to zero) of >300,000 accounts with leverage and the stranding of $10b or more in assets in FTX along with further contagion effects. Only Mt Gox hack was worse. Yet, the S&P 500 managed to post strong gains in the final two days of last week. This shows that investors are becoming more discerning, rather than “hit the sell button” on any bad news.
BOTTOM LINE: Case for a sustainable rally in equities is the strongest it has been in 2022
In our view, the case for owning equities is the strongest now than it has been in all of 2022. The reasons are cited above. But consider this additional perspective:
- Skeptics will say “growth is the problem now” and point to downside in EPS. But as we have written (see below), S&P 500 has historically bottomed 11-12 months before EPS troughs. So EPS is lagging.
- In 2020 and 2009, S&P 500 bottomed 12M and 10M before EPS bottomed. Since 1900, 13 of 16 major equity lows saw S&P 500 bottom before EPS. See table below.
- From 1982 to 1990, S&P 500 EPS only grew a cumulative 19% (or 2% per annum) but S&P 500 3X. Collapse in bond volatility (risk of higher rates) matters far more in our view
- If inflation is indeed slowing to a 3.5% annualized pace (0.2% to 0.3% per month, as we expect), this shows inflation is far less sticky than inflationistas have argued.
- While we have maintained that view “inflation not as sticky” (given the constellation of leading indicators), it is only now that we are seeing this in the “hard” data (CPI)
- Lastly, recency bias is keeping investors bearish. We have many clients telling us October CPI did “not change a thing. Inflation still too high and Fed will keep raising until something breaks”
- We still see a rally into YE
Rally should exceed the “June false dawn pivot”
As far as market implications, we think the case for a strong rally into YE has been strengthened:
- Foremost, Fed no longer has its “back to the wall” on inflation as October CPI beat looks repeatable and therefore the case for a pause after December is stronger. This counters the hawkish rhetoric of Powell post-FOMC but he did not have October CPI in hand.
- For most of 2022, Fed has not been able to point to measurable progress on containing inflation but a significant constellation of leading indicators showed deflation/soft inflation was in the pipeline. October CPI is the first month the “hard” data syncs with the “soft” data.
- Softening inflationary pressures strengthen the case for a “soft landing,” counter to the consensus narrative that Fed is spiraling economy to a hard landing. Core inflation running at 3.5% annualized (above) will not require Fed to bang out +75bp and arguably 4.5% Fed funds would be very tight.
- A Fed shifting from “higher in a hurry” to “predictable but possibly longer” is far better for risk assets. Fed has acknowledged serious and unknown lags in monetary policy and with inflation improving, Fed can gain some measure of patience.
- While some bears say the Fed doesn’t want equities to go up, this is an oversimplification. Fed just was in a hurry to slow things down in 2022. Stocks are far more complex than bonds which are arguably two variable assets (inflation and future Fed funds).
- Stocks are acting like “beach balls under water” because P/E averages 19X when 10Y between 3.5% to 5.5% — true since 1871. Thus, those arguing P/E should be 15X or less are just plain ignoring history.
- The “false dawn June pivot” rally lasted 23 trading days and saw S&P 500 rise +16%
- We believe this “Fed pause” rally should last closer to 50 days and push S&P 500 +25% higher. Thus, we think S&P 500 should surpass the 200D average of 4,100 and given possibility of another weak Dec CPI could see a move well beyond that. Why wouldn’t 4,400-4,500-plus be a possibility?
- Recall, in 1982, following the final low in August 1982, the S&P 500 reached a new all-time high within 4 months, erasing entire 27-month bear market. That was a vertical rally. Vertical.
We publish on a 3-day a week schedule:
Monday
SKIP TUESDAY
Wednesday
SKIP THURSDAY
Friday
_____________________________
37 Granny Shot Ideas: We performed our quarterly rebalance on 10/19. Full stock list here –> Click here
______________________________
