As probabilities of benign-er outcomes rise, FAANG/Nasdaq should rebound first

Soft surveys show probabilities rising of “growth scare” and other benign views…

The big event this week will be the May payrolls report. This is a case where bad news is good news. A strong jobs figure and anxiety will surge regarding an overly strong economy. As we discuss below, even if this proves to be a positive payrolls surprise, the underlying trends in the labor market seem to be softening sharply.

In conversation after conversation, investors describe the current macro environment as one of the most uncertain they have ever seen.

• one client (HA) mentioned that this environment has forced him to become extremely tactical
• his book becomes nearly flat at the close of every trading day
• the macro outlook changes so dramatically given the extreme data dependence, and in turn, whipsawing market views on Fed policy

And it is not just investors, look at the comments from bank CEOs. Earlier this week, Jamie Dimon cited “economic hurricanes” and Goldman Sachs’ President Waldron warned of unprecedented shocks. This is not entirely surprising given the combination of war impacts, supply chain glitches, labor shortages, COVID-19 behaviors among other uncertainties.

5 probable scenarios into YE: Markets and market consensus, in our view, overshot to downside…

While our base case for 1H2022 remains “treacherous,” we have maintained a relatively more constructive view on markets versus consensus. And over the course of 2022, consensus has become progressively more bearish given the cumulative uncertainties presented by the risks cited above. The sources of macro uncertainty were visible at the start of 2022, but the trajectory of these have been worse than expected.

But in looking at the balance of 2022, there are basically 5 scenarios (there are more, but these capture the essence):

• SEVERE: Wage-price spiral plus Fed error leads to 2008-like, equities decline 50%
• BAD: Fed overtightens and leads to a recession, equities down 35%
• SOFT LANDING: Fed base case of easing inflation, equities bottomed but stuck
• GROWTH SCARE: Goods prices deflate, job growth weakens, Fed done sooner, equities bottomed
• BENIGN: Russia-Ukraine war ends, China supply chain ungums, goods deflate, food deflates, equities bottomed

There are variations, as I mentioned, but these capture the essence.

…Consensus assigning too low probability for better outcomes

We are making some qualitative assessments. Based upon conversations with our clients, we believe investors are understandably focused on the downside scenarios. Incoming data, in our view, is supporting rising probabilities of better outcomes:

• generally speaking, we believe incoming data supports rising chances of benign outcomes
• as we discuss below, soft surveys show the labor markets softened sharply in May, even if payrolls report doesn’t show this

• goods inventories such as housing, autos and retailers are surging, raising chances of outright discounting
• and exogenous risks such as war and China re-opening could have positive developments
• key payrolls reports (May) is reported today (6/3) and next week is CPI, so a lot of data are forthcoming
• regional surveys like Dallas Fed among others show conditions are softening, so the economy is already cooling

And not all Fed speak is tilting uber-hawkish. As Loretta Mester in her interview Thursday in Philadelphia noted, there remains a scenario where Fed rate hikes are delivering the necessary tightening to slow job markets and deliver other impacts. While this is one of many voices, it is an important reminder that the Fed’s course is data dependent and will be methodically decided based upon incoming data.

And of course, markets and Fed ultimately care about bringing inflation and inflation expectations under control. As shown below, this is both market-based (breakevens) but also changing the perceptions among Americans:

• cooling jobs will help
• discounts on goods will help
• media and social media stories on prices will help

DeepMacro data shows job offers tanked in May

You might recall we have cited the work of DeepMacro in many prior reports. This research provider uses alternative and big-data sources to develop insights into the economy. One of their models pulls in job postings from >30,000 companies:

• their data shows May job offers dropped sharply from April (blue shaded area)
• job fills were steady, so this is a gap between the two
• looking at the chart below, this is the first time “offers” was below “fills” since 2020

Start-up layoffs 4X in May to ~17,000, wowand probably set to worsen given Sequoia’s memo

Private companies are more vulnerable to tightening financial conditions as they don’t necessarily have access to public debt and equity markets. And their reference cost of money tends to be high-yield or worse. Hence, the impacts of Fed policy changes are often amplified in private markets.

According to layoffs.fyi, layoffs at startups exploded in May:

• ~17,000 layoffs in May
• ~3,800 in April
• >4X increase in a month
• worst since May 2020
• layoffs might further accelerate as VCs warn of tighter times

Inflation remains top priority of policymakers

The White House and Fed met Tuesday and this is the first meeting since Powell was re-confirmed. The takeaways from this meeting are not entirely surprising and President Biden noted that he will give the Fed the necessary independence to fight inflation.

• per Biden “I agree with their assessment that fighting inflation is our top economic challenge right now”

And naturally, this remains a primary focus for markets. In fact, Eurozone reported inflation figures yesterday and inflation (HIPEC) came in at 8.1% YoY, above expectations. This figure is equivalent to the US “headline CPI” and includes food and energy. The “harmonized” figure (sort of ex-food/energy) is +5.7% YoY. Still uncomfortably high.

• similar to US concerns, investors fret that inflation will remain sticky
• hence, not only are investors focused on a peak in the rate of inflation, but also the pace that inflation weakens

US incoming data points point to cooling inflation

As our clients know, there is a growing constellation of incoming data points that show inflationary pressures in the US are peaking. We highlighted a few over the past few days, but the evidence of cooling inflation is broadening:

• retailers have too much inventory and soon will discount
• many commodities are now showing negative price gains YoY, including copper and platinum and lumber
• Morgan Stanley automotive team notes that the semi-chip shortage could be ending, leading to easing bottlenecks
• the WSJ reports that OPEC could exclude Russia temporarily and pave way for OPEC to increase production

One of the great risks for inflation is when ever rising prices become part of consumer expectations. This creates a negative feedback loop around wage expectations and even consumption habits — if consumers expect rising prices, this can pull forward demand. Hence, signs of falling prices, evident to consumers are a welcome development.

• as this article from CNN highlights, the piling inventory (we wrote last week about this) is leading retailers to begin considering discounts

this is a break from pricing strategies seen since the pandemic, where shortages led to ever rising prices

...even commodities broadly are showing deceleration of price gains YoY

One of the more interesting developments, in my view, over the past few months, is that commodity prices are no longer rising. In fact, as this chart from IHS Markit shows, many industrial commodities are down in price YoY:

• only Fiber and Energy are higher YoY
• iron, lumber, rubber, pulp, even industrial metals like copper and platinum are down YoY

We have highlighted 6 commodities below and we can see the declines YoY. The trends in prices seem to be mixed:

• iron prices have been rising since late 2021, but are still down YoY
• Rubber and pulp seem to be in uptrends, but are down Yo

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