STRATEGY: Equities have held up fairly well in the face of considerable uncertainty
In our conversations with clients, many believe that as long as the uncertainty of Russia-Ukraine war persists, stocks will have no bid. That is, many instinctually argue they cannot see stocks stabilizing until we have a clear path to exit this conflict. History, as we have highlighted many times, would disagree with this. In overly simplistic terms, the path of markets is not solely dependent on the future path of events:
- future path of events is key = future
- equally important is investor expectations of future path = consensus
- investor positioning relative to future path = positioning
- investor risk appetite relative to future path = VIX and sentiment
- policymaker action and reaction to future events = Fed put and fiscal response
So, as shown above, investors seem overly focused on the first driver only. But 4 other factors have an important impact.
- that is why Tom DeMark’s observation “markets bottom on bad news, not good” is key
- that is why Tom Luddy’s adage “less bad = good” is key
In the 2022 context, what this means is that the S&P 500 can bottom well ahead of the Russia-Ukraine conflict bottoming. We believe the odds still favor 2/24 to be the low for 1H2022. We think the probability is more than 50%, maybe 70%-75% but it is not at the “no brainer” level. And this all feeds into our expectation that 1H will be treacherous.
Recent events have improved the probabilities, in our view:
- Fed, in its testimony this week, “pre-released” 25bp for March FOMC meeting
- meaning, the “hike” was this week, and 3/15 is a formality
- the “hike” band-aid was ripped off this week
- Russia progress has been below expectations
- Russia-Ukraine are holding peace talks 8 days into conflict
- Pre-invasion, many pundits expected Russia to be victorious after 8 days
- China is now exploring ways to move off “zero case” policy
Half-full is prevailing since the start of the invasion
And in the face of these headwinds, stocks are still making jagged progress higher. This is consistent with the view of Mark Newton, Head of Technical Strategy at FSinsight, who says that stocks are making a “two steps forward, one step back” progress.
- in short, a “half-full” perspective is prevailing since the start of the invasion
- while pundits cite a litany of market risks
- equities have managed to inch higher
- and VIX falling lower
Thus, our current view is that 2/24 was a bottom, but this remains in the context of our “treacherous” market view of 1H2022.
RISKS AKA WHAT COULD GO WRONG: Most obvious is Russia escalates conflict
In our view, punditry is on full display. Plenty of market pundits are calling for a global recession or Russia to escalate this war and I thought it would be helpful to review the risks:
- Russia elevates the conflict to other nations
- Russia launches a successful cyber attack on the US financial system
- Russia decides to disrupt financial markets or equities by hacking exchanges
- Iran or a hostile nation takes advantage of this turmoil to launch its own incursion
- North Korea decides to do something rogue
I mean, there are many things that could go wrong. Hence, we see 1H as treacherous, but 2/24 as a growing probability of 1H low.
Markets don’t bottom on good news, but bad news…
We have been meeting with a considerable number of investors over the past week, both in person and via zooms. I have found few who are constructive on equities. In fact, in a way, investors’ negativity is similar to March 2020:
- many believe economy is late cycle
- Fed tightening was “peak of bull market” already
- Russia-Ukraine war has a high risk of dramatic escalation to include Europe and US personnel
- inflation war already lost with “Fed behind the curve”
- oil causing recession
So, the consensus is pretty concerned. And anyone listening to business news, twitter, or anything will find a steady drumbeat of pundits saying we are already in a bear market.
- consensus could be right
- this sell-off is the start of a broader market decline
The tweet below is from nobody of significance, but this sentiment is common and a consensus view. Inflation going to hit earnings, thus, stocks will go down.
But the yield curve did not get this memo. As you can see below, the long-term yield curve is pushing higher, quietly:
- the long-term yield curve is largely unaffected by Fed policy
- our prior analysis shows Fed has enormous control on 1M to 5Y rates
- beyond 5Y is “market based” – steepening curve is often a sign of strengthening economic outlook
- this could be a result of falling inflation
- higher growth expected from “wartime economy”?
- other factors
In any case, this takes us back to markets. Markets don’t bottom on “good news” coming. They bottom on bad news. That is, the bottom is when stocks favorably respond to negative events.
- the obvious is therefore whether 2/24/2022 was the bottom
- in our view, this is the key date
Central banks are incrementally turning dovish = Fed put coming into play
There are several general principles at FSInsight, which we detail below (see our “2022 outlook” or any prior outlook for this list). And as you can see, the most important of these rules:
- Don’t fight the Fed
- and
- if in doubt, check the rule “don’t fight the Fed”
And in 2022, this rule #7 was in play, because the Fed made a “hawkish” pivot, citing the need to move aggressively. And this was one of the reasons we expect 1H2022 to be treacherous.
- however, the odds of a Fed hike in March 2022 are dropping drastically
- it is now below 1.0 hikes for March and at 0.90
- lowest odds since Jan 2022
- 10-yr yields also falling, confirming this
- 1 and possibly 2 hikes are coming off in March
- that is a “DOVISH” pivot
Yes, dovish.
Same story with ECB. In February, the futures markets saw 5 hikes by ECB by Dec 2022.
- the number of hikes is quickly approaching zero
- yup, 5 hikes coming off the “table”
- that is a “DOVISH” pivot
So, the central banks are becoming incrementally dovish
Figure: Themes in 2022 – “BEEF”
Per Fundstrat
Figure: Fundstrat Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
