OPPORTUNITY: S&P 500 closed >200D second consecutive day = massive technical recovery

As many in the markets like to say, “price is the final arbiter.”

• for much of 2022, our view that inflation would fade faster than consensus was a battle against massive market liquidations and growing fundamental concerns
• but as the chart below shows, the S&P 500 has managed to claw its way back above the 200D moving average (4,062) and has held this level for two consecutive days
• in the “crisis” of 2022, this has not happened (see below), so this is a break in pattern

And as Ryan Detrick @RyanDetrick of Carson Group highlights, recovering the 200D has positive forward implications. Per Ryan:

• only 13 times since 1950, S&P 500 below 200D for >6 months and recaptures 200D
• 3M later: 11 of 13 times higher, 6.7% avg gain
• 6M later: 12 of 13 times higher, 12.2% avg gain
• 12M later: 12 of 13 times, equities higher 12M later with avg gain +18.8%
• Overall, a positive signal
• The only real blight in this is January 2002. This was the only failure.
• Looking back at GFC, this recapture of 200D did not happen until June 2009
• Looking back at pandemic, this recapture did not happen until Nov 2022
• Food for thought.

STRATEGY: What works if inflation crisis is broken? Tech + Small-caps + High P/E + Heavily Shorted

Here are some thoughts about what could work into YE.

Foremost, for stocks to work into YE, the inflation crisis has to be broken. That is, we think the Nov CPI (12/13) will finally convince investors inflation is falling faster than expected. Falling like a rock.

If so, we see the following things changing in consensus expectations:

• yields fall as markets see lower “terminal fed funds” and falling risk premia = 10Y to 3.5% or lower
• mortgage rates fall even as well as there is “excess spread” in 30Y fixed rate mortgage which is historically 150bp above 10-yr yield. Thus 30Y mortgage = 5% not 6.5%
• USD weakens as markets see Fed pivot
• EPS expectations rise as weaker USD reverses 20% rise in USD in 2022, which subtracted 5-8% EPS

What types of stocks work?

• heavily shorted names rally
• AMC 2.78%  CNK -0.70%  ARKK 0.72%  COIN -2.32%  CCL -0.85%  WYNN KWEB 0.60%
• high P/E stocks which are down 90%-98% get “rented” to be down only 60% from highs
• ZM CRWD -1.83%  SHOP 2.20%
• Technology stocks, which have been hardest hit due to higher rates (lower P/E) surge
• QQQ 0.97%  AMZN 1.41%  MSFT 0.51%  NFLX 0.89%  SOX GOOGL 1.05%
• small-caps rally as investors see cyclical recovery
• IWM 0.15% ANGI -1.60%  HOG -1.17%  SIX 0.72%  TPX 2.35%

These are representative tickers and not stock recommendations.

If someone asked me where my view differs most sharply from consensus, it is the following:

• CONSENSUS: inflation “sticky” and will take years to fall to Fed target
• CONSENSUS: Fed won’t slow hikes until inflation ~2% or something breaks
• CONSENSUS: US economy tipping into a recession
• TAKEAWAY: Consensus is bearish and sees no reasons for stocks to sustain a recovery until AFTER a recession.

Our view:

• Inflation already breaking to downside and next few CPI prints are 0.2-0.3%, or ~3% annualized.
• Fed soon will see “sustained signs” of falling inflation rates and playbook will change. Fed last hike might be December 2022.
• US economy has been incredibly resilient and soft landing on tap, driven by a major softening of labor markets but not necessarily rise in unemployment.
• TAKEAWAY: So divergent from consensus, when consensus shifts towards this view, stocks will see “near vertical” rally

Our view for 2022 was 1H would be “treacherous” but in 2H, our view for markets is favorable. And given the risk-off positioning of institutional investors (see note from Monday) and given the extreme bearish retail sentiment (AAII, etc), there will be an abrupt market adjustment higher.

STRATEGY: Do you see the setup into YE?

So do you see the setup? It all comes down to whether inflation is convincingly cooling. The job market certainly is, as we noted above.

Sure, there are challenges still ahead but many of these are getting better now…

• EPS estimates –> too high? maybe but markets bottom 11 months ahead of EPS
• Labor market is tight –> this is no longer true
• Fed drives economy “off the cliff” –> yes, if Fed keeps looking at “hard data”
• Recession risk –> yes

STRATEGY: Given the above, we see possibility of S&P 500 reaching 4,400-4,500 by YE

We think this rally has more support compared to the June “false pivot” rally to 4,325 (see below).

• SPX remains on course for higher prices into mid-to-late next week. Wednesday’s sharp gains look to have begun the (possible) final move from October 2022 lows which might stall out into 12/7-9.  Targets at 4120, 4144-6.
• US 10-Year and 30-year Yields have been pulling back sharply of late, but the one thing that piques my attention these days is the breakdown in the 2-year yield. As of Thursday, 12/1’s close, the 2-Year yield has successfully broken the neckline of a one-month Head and Shoulders pattern. This is a key piece of the process in suggesting the market is starting to anticipate a potential slowdown in the FOMC’s rate hikes in the months to come
• Bitcoin’s rally to multi-day highs on Wednesday gave the first real proof that a counter-trend bounce was getting underway. BTCUSD shows prices having closed at the highest levels since 11/10 and volume expanded to new highs for the week. A further rally looks likely into early to mid-December with initial targets found at 18,150.

• The S&P 500’s rally that began at the October lows is still trying to work itself higher on hopes of softish inflation and a throttling back from the Fed. My strategic indicators continue to not support this move let alone a significant rally from current levels. Caution is warranted.
• My take on Chair Powell’s speech was not dovish and I was surprised how the equity market’s reacted with its 3% thrust higher. Not only did I not take his words to be bullish, but I am in fact am concerned that things are actually worse — higher for longer.
• The work I do on earnings and revisions still strongly suggests that forward profit expectations are too high and still have a ways to go before they overly discount reality, which will the point when my work will flip to favorable. Indeed, the current bottom-up consensus for 2023 CY OEPS is near $240, but preliminary work that I am doing suggests $200-215 is more realistic.
• The historical analysis that I have done suggests that the NTM P/E multiple based on $240, which most agree is too high, values the S&P 500 at 17x. This level is not egregious but would show the index trading at near full price. Importantly, if the earnings are closer to $200 and my fair value multiple level of 15-16x ends up being reached that targets 3200-3000 for the S&P 5000.
• The economic data is quite diverse and shows a mix of some strength, some weakness, headline inflation decelerating, and labor market/wages holding up. Indeed, the average hourly earnings increase released in today’s NonFarm payrolls is problematic for Chair Powell and for dovish expectations for future policy moves.
• Bottom line: aggressive tactical indicators that have been tilted towards supporting a bounce are getting stretched but have not flipped to unfavorable. Thus, there could be further upside into year end, but for strategic investors my work still strongly signals that this rally is just a “get out of jail free” card for investors as there is still considerable downside risk as we move into 1H23.

• Retail sentiment dropped like a stone this week. If you were looking for a very short-term constructive indicator, this would be support for a short-term rally in the next week.
• However, from a valuation perspective, if you compare equities to investment-grade yield, equities are still very expensive.
• When you combine this valuation with earnings and margin forecasts, which are likely to shrink, this is not great for the market over the next three to six months.

• We have gained some distance from the FTX implosion and have likely seen most of the forced selling and collateral damage. However, the outcome of DCG remains a critical unknown.
• The market looks quite different post-FTX. We’re seeing low volumes and low liquidity, leading to a range-bound and gappy market.
• It will be essential to watch correlations with macro assets in the near term. Some short-term correlations to macro returned this week, but we did not see the beta to tech we have become accustomed to seeing.