Stocks up 65% of the past 20 trading days, highest since Nov 2021, and a reason it is starting to "feel like a bull market." We expect 1Q23 EPS to exceed expectations, likely 2H23 trough in EPS = supporting strengthening breadth.

Tom Lee, CFA

The S&P 500 is up 8% YTD (~+20% in the past 6 months) and at this pace, is annualizing returns of ~30% -- that is not our forecast. And as we highlighted earlier this year, the "rule of 1st 5 days" (neg prior year and >1.4% gain in 1st 5 days) implies ~20% gain for 2023.

  • But despite these fairly impressive gains, this does not "feel" like a bull market for investors. There are several reasons for this including (but not all): (i) Fed is tightening and has stated that it intends to keep hiking (even as bonds call opposite); (ii) EPS estimates are down and YoY is negative (nadir in 2H23) and (iii) the stock market just doesn't feel consistently rising -- last Friday's reversal is an example.
  • The stock market is beginning to "feel like a bull market" as the % of up days (of the past 20) reached 65% last week -- the highest figure since Nov 2021. For the 15 month period from Dec 2021 to March 2023, this figure never exceeded 60% and was a crushing mere 20% on Oct 12, 2022. That date of that 20% reading is also the date of the recorded low.
  • The first chart of this note shows this ratio curled up sharply and we believe will soon reach 70% in coming weeks, aided by what we expect to be better than expected 1Q2023 EPS results. And as such, the rise in equities will soon "feel like a bull market."
  • The 6 month average for this is only 46%, which is below the 53% LT average. Thus, this explains why stocks have risen 20% in that timeframe, but this feels like a bear market to investors. Stocks in the past 6 months have not risen with sufficient frequency to feel like a bull market.
  • The 4 sectors with the best % up days ratio is Healthcare ($XLV), Utilities ($XLU), Basic Materials ($XLB) and Industrials ($XLI) and is the second table. But of these, the EPS revisions have been negative for Healthcare and Utilities, so these are not as attractive as Materials or Industrials.
  • Regarding 1Q2023 EPS, the first reports by major banks beat consensus estimates by 9% to 20% ($JPM $WFC $PNC $C) and data by Refinitiv/Eikon show that 1Q2023 EPS estimates overall declined (vs 3M earlier) by -6.4%. While this sounds bad, this is lower than -7.4%/-6.6% of 4Q22 and 3Q22, respectively, meaning, the downward drift in EPS estimates is somewhat bottoming.
  • As for the drivers of down 1Q2023 EPS, the largest contributor is Healthcare (-19% $XLV) which is -3% of the -5% overall EPS decline. The 3 worst EPS revisions have been Moderna ($MRNA), United Airlines ($UAL) and Newell Rubbermaid ($NWL), so this does not feel like "Cyclical EPS" is falling apart in 1Q23.
  • We will get a better sense for 2023 EPS and 1Q23 results as we move through earnings season in the coming weeks, but we think the overall tone will be positive. So far, 32 companies have reported and 84% are beating, by a median of 7.7%. In fact, tracking 2023 EPS estimates since the start of the year, it looks like 7 of 11 sectors could be seeing EPS estimates somewhat bottoming. Basic Materials ($XLB), Industrials ($XLI) and Staples ($XLP) look fairly definitive. The 3 sectors seeing consistent downward revisions are Energy ($OIH $XLE), Financials ($XLF) and REITs ($XLRE). The latter 2 are not surprises.
  • There are several factors supporting stabilizing 2023 EPS. The first is the USD has flattened out and USD strength might have subtracted -5% to -7% of EPS in 2022. The other are global PMIs have turned back higher. The JPMorgan Global PMI composite has risen for 4 consecutive months now and is now at 53.4, the highest reading since December 2021. So while US PMIs are still weak, the rest of the world is firming. Global GDP is generally correlated to global PMIs and higher GDP = higher EPS.
  • As for the Fed tolerating easing financial conditions, we think this remains the active debate in the market. Those cautious believe the Fed sees greater risks of allowing inflation to flourish versus the downside risks of overtightening. But an increasing number of economists argue the current Fed hikes are set to deliver slowing inflation (our view) and many now see higher unemployment as possibly unnecessary risks (see below). And coupled with the tightening of credit coming from the regional bank crisis, this supports the reasons the bond market is seeing a far more dovish rate path than the current Fed view (SEP, or summary of economic projections).
  • Ultimately, this comes down to inflation easing and we believe inflation is on a sustained and faster (than consensus) decline. We will provide more details in our First Word on Wednesday morning. But this reflects the fact that a sufficient number of inflation components are declining and inflation is set to fall faster than consensus expects.
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