The biggest takeaway for me on events of this week? Convincing and arguably decisive evidence the “bottom is in” — the 2022 bear market is over.
- this was a big data week, with FOMC, 2Q GDP, housing and PCE (today)
- a huge miss on GDP, yet markets rally
- Fed raises +75bp and says focus remains on inflation, yet markets rally
- Russia turns down gas flow on Nord Stream I, yet markets rally
When bad news doesn’t take down markets, it is time for investors to assess.
- Is this a trap driven by short covering?
- Most investors take this view
- Has economy reached the pivot point where incoming data will be decisively less negative?
- This is our take and disinflation tailwinds strengthening
…This is the August 1982 moment, bottom is in but Fed is two months away from a pivot
As we have written about in multiple reports in recent weeks, we think this is turning out to the be August 1982 moment:
- During Volcker’s war on inflation, equities bottomed on August 1982
- this is two months before Volcker abandoned “anti-inflation” measures
- More importantly, stocks recovered the entire 36 month bear market loss in 4 months
- a mere 4 months
- in 2022, this means stocks could see “new highs” before YE
- yup, that is why we think S&P 500 could be >4,800 before year-end
EPS: Despite strong USD, global-oriented companies generate strong EPS growth
2Q GDP was the second consecutive negative GDP print, yet earnings are performing better than expected. As shown below:
- 40% of the S&P 500 has reported
- 71% are beating on EPS, and 72% of cyclicals are beating estimates
Despite a strong USD, EPS growth for global-oriented companies is >10% growth.
- this is impressive considering the headwinds of strong USD, bloated inventory, bullwhip effects
- and negative US GDP growth
- although those companies with higher US-rev share are only seeing 1% EPS growth
And reminds us that these companies have vastly improved operating efficiency during the pandemic. They are “unkillable” and inflation is a problem but they are managing well.
Another reason markets rally is the “negative tails” are being reduced
Multiple factors explain the recent market rally but perhaps one of the biggest factors is the fact consensus had been expecting a far worse outlook for the economy in 2H:
- hard landing as Fed is forced to crash economy to contain inflation
- inflation would be sticky so terminal rates would be higher than expected
- this is a negative for equities
- but as we noted market-based measures of inflation show markets see inflation being far less sticky
In fact, the comments below by Jeff Gundlach speak to this. He makes clear he does not see a “crash landing” and yet, the plurality of our clients expect a crash landing.
And this ties back to the market’s bias to see negative outcomes for markets. As shown below, there are 5 basic scenarios in 2022, and the Fed has stuck to the central case of a soft landing:
- recent data is confirming this central case is tracking
- while many investors and consensus see downside risk
- that is why investors have called for a “buyers strike” until S&P 500 falls to around 3,000
- but we believe a decisive bottom has been set
COGNITIVE BIAS: Investors see what they want to see
Over the past few years, we have highlighted that cognitive bias can make investors interpret events based on their own biases. In 2022, this is on ample display:
- inflation risks, either we have structural or more transitory inflation
- Fed is either overly hawkish or too dovish
- economic momentum is slowing or crashing
And these biases are built into our brain. Take a look at the 3 colored balls below:
- our brains see 3 colored balls
- red, yellow and blue
- unless someone is color blind (there may be fewer lines)
COGNITIVE BIAS: Markets see what they want to see
Zooming in, one can see that every ball is the same color:
- all balls are beige
- but like the above illusion, all incoming data is “colored” by our biases
- the signal from the markets, in our view
- is inflation risks are proving to be more transitory than many expected
COGNITIVE BIAS: Every ball is beige
INFLATION BIAS: Surveys show inflation a “political issue”
Even perceptions of inflation are subject to bias:
- U Mich survey also shows inflation expectations by political affiliation
- In past few years, Republican voters see far greater inflation
- Inflation expectations for the next year are >10% for Republicans and ~4% for Democratic voters
- 4% is the average value for Democratic voters since 2016
- There is no “inflation” issue arguably for Democratic voters
This is corroborated by Pew Research which shows inflation:
- issue for 84% of Republican voters
- only 57% for Democratic
And YouGov shows the same
33 GRANNY SHOTS: Updated list is below
The revised 33 Granny shots is shown below. The list on the table below is sorted by the most attractive (most frequently cited) to least. To be a “Granny shot” the stock needs to appear on at least two portfolios:
- AAPL 1.84% in 5 of 6 portfolios
- GOOGL 0.77% MSFT 1.18% in 4 of 6 portfolios
- AMZN 0.99% META 1.33% in at least 2
- This reinforces our favorable view of FANG in 2H2022
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
Portfolio strategy introduced in December ’19 rebalance, replacing 2019 portfolio recommendation – “FANG in odd years”
