Things are so bad, that markets can bottom on bad news
I am a huge Nicholas Cage fan. Some of his earliest movies had an influence in my youth — Peggy Sue Got Married, Moonstruck, Leaving Las Vegas, the Rock, Con-air, etc. Even some of my all-time favorite movies are Nicholas Cage movies like Family Man, or It Could Happen to You. But as with any legend, he has made some movies that have been panned. That is why this story by Inverse.com caught my attention.
- Nicholas Cage made the WORST sci-fi movie of all time and also his BEST
- this made me think of the investment environment
- so bad, it is good
4 reasons yesterday is like a bad Nicholas Cage movie
There are 4 reasons we believe the current market environment reminds me of a “bad” Nicholas Cage movie:
- GDP 1Q2022 print was -1.4%, below consensus of +1.0% = weaker economy = doing Fed’s work = so bad, it is good
- Retail AAII sentiment came in at -43%, 6th worst since 1987 = contrarian buy signal = so bad, it is good
- Nasdaq underperformed S&P 500 by -11% past 6M, one of 13 worst stretches since 1985 = outperforms S&P 500 77% by 950bp = so bad, it is good
- Facebook reported weakening 1Q2022 results but stock rallies +20% due to pessimistic expectations = so bad, it is good
See the pattern? As is the old adage, markets bottom on bad news, not good news
GDP 1Q2022 negative, but the headline is not the focus of markets
1Q2022 GDP came in at -1.4%, below consensus of +1.0% and down sharply from +6.9% in 4Q2021. The details are not as bad as the headlines. But the implication for me is as follows:
- 1Q2022 GDP undermines those who see the US economy is so hot, and the “Fed needs a hard landing”
- Core PCE is still healthy +5.2% QoQ but this is below the Street consensus +5.5%
- Friday 4/29 is PCE core deflator. This is a key component followed by Fed
- Street looking for 5.3% YoY, down from 5.4% YoY in Feb.
- Below 5.3% YoY would be considered a positive development for markets, in our view.
As shown below, 6 components were the primary contributors to a decline in GDP:
- 6 items subtracted a collective -4.8% from 1Q2022 GDP (vs year ago)
- The biggest subtractors were imports, exports, inventories, fed spending
- and also gasoline and clothing
So, it was not only an inventory correction. Govt spending is cooling. And gasoline and clothing were big contributors in 2021 due to supply chain shortages and sizable increases in price.
- does this change the Fed path to hikes?
As shown below, on Thursday’s trading session, there was a modest uptick in the number of Fed hikes expected by December 2022. But:
- # hikes expected by YE is 9.6
- # hikes expected last Friday 4/22 was 10.1
- # hikes expected has fallen given incoming data over the past week
SENTIMENT: So bad, only 5 times when retail sentiment worse= risk/reward 6M-12M STRONG
As our clients know, we like to use the AAII (American Association of Individual Investors) sentiment survey. This weekly survey has been conducted since 1987 and we believe it generates a lot of signals at the extremes when the survey is very bullish or very bearish. The drawback of this survey is that it tends to sample older Americans, so it is not capturing the sentiment of the Reddit crowd:
- the latest reading % bulls less % bears came in at -43%
- as indicated, this is rare
- seen only March 2009 and prior to that in 4 weeks Sep to Oct 1990
- only 5 weekly readings are worse than the latest
STRATEGY: Nasdaq 100 worst 6M relative performance to S&P 500 since dot-com bubble
Equities remain under a buyer’s strike. This has been a bludgeoning since last Thursday. The carnage in NASDAQ continued Tuesday, with large-cap technology down 3%-4%, spearheading the downturn associated with the broader market buyer’s strike. As shown below:
- Nasdaq 100 has underperformed the S&P 500 by 950bp in the past 6 months
- this is the worst since the dot-com days (2002 era) or worst in 20 years
…Nasdaq underperformance is in the bottom decile = historically, strong forward signal
The deciles of relative return are shown below and the associated 6-month forward performance. Notice something startling?
- when Nasdaq 100 QQQ underperformance is bottom decile (like Tuesday)
- forward 6M returns extraordinary
- ex-dot-com, 6M returns beat S&P 500 97% of the time
- relative outperformance is 950bp
In other words, there are factors aligning favoring a bounce in Tech/FANG/Nasdaq:
- rates stabilizing
- underperformance so acute, that it reverts
- Technology can still grow in a growth recession
…Sector leadership is not showing recession risk as much as anything but Technology
Below is our sector performance chart and the relative staging of the sectors. The reason I am showing this chart is to highlight that sector leadership is not really signaling a recession:
- if a recession were imminent, we would expect Defensives to lead such as Staples, Healthcare, Utes and Telcos
Leadership, instead is a combination of:
- Energy + Materials
- Defensives
- Stabilizing performance of Transports, Industrials and Financials
This is eclectic. As shown below, we have labeled the relative explanatory variables. So sector leadership is really a result of:
- inflation –> Energy + Materials
- “real” GDP growth –> Industrials + Transports
- rising rates –> Financials
- “risk off” –> Defensives
So, as ugly as this tape has been, it also does not necessarily signal a recession risk broadly. If anything, this seems to be more about the relative underperformance of Technology/ Nasdaq.
…US rates have been falling for the past 7 trading sessions, but equities not yet reflecting this
Earlier this week, we noted that JPMorgan Fixed Income strategists talked about the fact that the interest rate market has priced in a nearly “max hawkish” view of rate hikes. That is, they saw little room for rates to push higher, as markets were pricing in a lot of tightening.
- this seems to be the case in the past 7 trading sessions
- despite Fed Powell’s increasingly hawkish interview at IMF on 4/21 (see below)
- both 2-yr and 10-yr rates have been falling
Figure: Themes in 2022 – “BEEF”
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019