Markets End Lower Ahead of Fed Week, November CPI Array ( [cookie] => 21bfe5-8002c6-03b83f-7d4eb7-fe7908 [current_usage] => 1 [max_usage] => 2 [current_usage_crypto] => 0 [max_usage_crypto] => 2 [lock] => [message] => [error] => [active_member] => 0 [subscriber] => 0 [role] => [visitor_id] => 0 [reason] => Usage under limits [method] => ) 1 and can accesss 1
Our Views
Why is the US essentially the worst stock market in the world? With the weakest bounce?
Arguably, the US has best weathered the trifecta of global turmoil–global inflation, surging oil and China zero COVID–among any major nations. We know that US has been fundamentally the “best house in a bad neighborhood.” This is evidenced many ways but consider:
- Fed has raised interest rates +400bp in 2022
- yet, the US economy continues to produce solid real GDP growth and employment has held up
- and inflation has been falling visibly
In comparison:
- Europe has suffered from far greater inflation due to surge in oil and commodity prices
- China’s economy has suffered from crippling measures associated with zero COVID
- Japan has experienced a near catastrophic drop in the yen
Yet, despite the obvious robustness of the US economy, the US equity market is among the worst performers YTD:
- peak to trough, the US fell -28% and as shown, is the worst of any major nations except for those 3 Asian nations Hong Kong (-53%), China (-40%) and Korea (-36%).
- and the US rise from the low is only +10% which is dwarfed by other nations including Germany which has surged +20%. Germany only fell -27% peak to trough, which is less than the US
RETRACEMENT: US only recovered 29% of decline, while Europe 45% to 77% retracement
This also puzzles me. This is looking at retracements, or what share of the decline has been recovered:
- the US has only recovered 29% of the decline (10% recovery after a 28% decline)
- yet, other major nations have seen 45% to 77% retracements including Germany (54%), Japan (47%), UK (77%) and even Brazil (38%)
- to me, this is not consistent with the US having the best economic outcome arguably
SOME WHYS: Some possible explanation for why US has not fared better
Here are some possible explanations for why the US has fallen more than other nations, and recovered less:
- Fed has raised interest rates the most, thus, hurting US valuations most –> but this means RoW is behind, arguing rest of World should not have sustainable outperformance
- US outperformed for longer thus this is payback –> but if US is strongest economy (vs RoW), shouldn’t US recover fastest?
- US stocks were more expensive than RoW –> so valuations are converging
- USD has risen +18%, hurting US earnings –> but flat/falling earnings is now a tailwind
- Investors have panicked and sold the US –> thus, if US inflation recovers, US equities should bounce
Ultimately, this is why we see the incoming November CPI report as crucial. These crucial incoming economic events arguably will determine the path of markets for the next six months:
- 12/13: Nov core CPI consensus +0.3% (+0.27% last month) –> crucial but expecting positive
- 12/14: Dec FOMC consensus +50bp
GLOBAL INFLATION: Lots of downside reads in the past few weeks
Inflation is falling rapidly globally and there have been many downside reads as shown below:
- Germany CPI saw outright deflation in Nov -0.5% and this was true for Eurozone broadly
- Even Mexico CPI saw a downside read and YoY is falling
Remember how economists said gasoline prices “soar like a rocket and fall like a feather?” That is not the case today. Oil and gasoline prices are plunging like a rock,
- Oil prices are at the lowest of 2022
- This despite Russia-Ukraine war still raging and the end of the SPR release
- and contrary to those who said oil and gasoline would only drift downwards gradually, prices have fallen like a rock
- There was a pullback this week for US Stocks, which is a little bit of a concern. I think this sets up for choppy and potentially down December, but it’s possible there could be a bounce early next week ahead of the CPI report and FOMC meeting.
- The energy sector’s pullback looks nearly complete after Crude’s move to new 2022 lows. While WTI Crude’s decline has finally resulted in some near-term weakness for Energy, this sector remains a leader over all other S&P GICS Level 1 groups on a 6, 9, and 12 month basis. Energy has not broken down below key support, meaning this pullback is still buyable for this sector.
- Gann’s Mass Pressure index peaks this week, on schedule for a pullback into December expiration. This has been largely correct for most of 2022 in pinpointing highs and lows, and until proven otherwise, this period between December 8 into December 21 looks to be the final pullback for the year before the end of December push into 2023.
- Danger signals are once again flashing, and equity investors should be on full alert as my strategic work still is not supporting a strategic rally, which are 1) forward profit expectations remain too high, and cuts are still required; 2) valuation levels still need to adjust lower; and 3) higher for longer from the Fed.
- Yes, the run to year-end will be challenging with key data releases, an FOMC meeting, and positive seasonals, so the S&P 500 could end 2002 anywhere between the wide range of 4200-3600.
- But regardless of what the final index price level for 2022, my analysis says 1H23 will be filled with considerable downside equity risk. My next downside target range remains 3200-3000.
- I released my updated sector recommendations earlier this week and there were no changes —Full Above Benchmark (Health Care and Staples), Tilt Above (Utilities and Energy) and Full Below Benchmark (Industrials, Materials, and CD) Tilt Below (Comm Services and Financials).
- Our market valuation methodology continues to see equities as overvalued relative to investment-grade fixed income. We expect muted returns and elevated volatility for the equity market in the coming months.
- Four of the five composite factors that make up our stock rating model outperformed the S&P 500 index in November, with quality (+2.8%) and value (+2.3%) leading the way.
- The reward for beating earnings estimates is high right now. This is beneficial for investors who can identify differences in stocks. The problem is fewer stocks are beating this quarter than in previous quarters this cycle.
- It remains crucial to monitor correlations with macro assets. We still haven’t seen them return to pre-FTX levels, and they remain quite range bound.
- We’ve seen the GBTC -4.85% discount draw down this week, approaching a new low. Counterintuitively, this is a good sign, as it could mean that assets held at the Grayscale level are being sold to fund operations and pay down some of the liability to Genesis. It will probably be a drawn-out process, but we might get more insight going into Q1.
- Weekly and 30-day volatility has fallen off a cliff since they peaked in early November, so heading into next week, the one potentially interesting short-term trade right now is in volatility.
- Sen. Raphael Warnock’s runoff victory in Georgia ensures that Republicans in the Senate will fall under the 50-seat threshold, with fewer seats than the Democrats even with Arizona’s Kyrsten Sinema changing her affiliation from Democrat to Independent.
- Sen. Sinema’s decision mostly affects her next election, as she avoids the threat of a Democratic primary challenge.
- The current Continuing Resolution to fund the federal government expires next Friday, December 16. There is some headline risk surrounding a potential shutdown, but I believe this will ultimately be avoided.
Wall Street Debrief — Weekly Roundup
Key Takeaways
- The S&P closed Friday at 3,934.38, down 3.37% for the week. It was down four days out of five this week. The Nasdaq closed at 11,004.62, down 3.99% for the week.
- The Producer Price Index rose 7.4% last month from a year earlier, down from the 11.7% peak in March. The data disappointed investors who had hoped for signs of easing inflation before the Federal Reserve’s meeting next week.
- The U.S. average for regular unleaded gasoline fell to $3.29 a gallon, dipping below its average of $3.36 from last year. That’s down about 35% from its peak of about $5 earlier this year.
Good evening,
The chop continues ahead of two significant events on the year-end calendar: the November CPI report releases Tuesday, Dec. 13, and the Federal Reserve’s final meeting in 2022 is Wednesday, Dec. 14. An expected rate decision should dictate how markets end the turbulent year. Will we see a Santa Claus rally once again?
The S&P 500 fell -1.4% on Tuesday, its 59th decline of 1% or more this year. Since 1950, the only years with more +1% declines than 2022: 1974, 2002, 2008. This fraught environment was the focus of our weekly huddle Thursday morning in New York. Here are the key takeaways:
Favor energy, cautious about Technology. Mark Newton, our Head of Technical Strategy, returned from a week of client meetings in Japan with our Head of Research, Tom Lee. While he was away, the market mostly fell, which Newton characterized as a “bit concerning” because we broke a minor uptrend from the October low. Volume and breadth have pulled back, setting up for what could be a choppy final three weeks of the year. Energy, which has been the top sector for the past two years, was one of Newton’s top picks entering 2022. (Our other research heads have generally been in agreement on this.) He remains constructive in the area even as crude prices have fallen. Here’s Newton:
- "I don’t love Technology over the next couple of months, which could be a headwind for equities overall. We are counting on healthcare to pull us through. It could be a difficult and unusual December for most people used to markets going straight up at year-end.”
- “For those trading, 3700 is the real line in the sand. Under that would give me real worry about a test and break of October lows.”
Brian Rauscher’s earnings work shows continued downside risk. Rauscher, our Head of Global Portfolio Strategy and Asset Allocation, says his work makes him more bearish than at any point this year. He has the fewest number of favorable stocks since the March 2020 lows, and his work predicts we have not yet reached maximum pessimism regarding the economy. His work also shows the S&P 500 will test the October low and go through it. Healthcare (flat on the year) is one of the few bright spots, along with staples.
“They are actually breaking out based on what I see,” Rauscher says. “To me, this is classic defensive positioning. Taken together, markets are pointing lower. It doesn’t have to be straight down. However, any strength next week would be the last chance to position for more downside. This is not a buying opportunity in my opinion. The only thing that will change my view is if CPI did fall off a cliff. I am not expecting that.”
The market remains expensive. That’s according to Adam Gould, our Head of Quantitative Research. His Reddit retail sentiment indicator has “been jumping around like a hot potato,” a high reading that could signal a market selloff next week. For investors who can identify stocks that will beat earnings, this environment is ripe for reward: Stocks that are beating have been rewarded nicely. But fewer stocks are beating. “The market overall is expensive,” Gould says. “It's slightly less expensive than it was (in October), but it's expensive.”
All told: Newton, Rauscher and Gould are all cautious as the year ends, with work that suggests more downside lies ahead.
Elsewhere in the World
China relaxed its COVID restrictions this week. Rumors on Monday of the pending changes sent the Hang Seng soaring 4.55% in response, while the Shanghai Composite Index closed up 1.76%. Wednesday saw Beijing release a nationwide update of its COVID policies, drastically narrowing the circumstances under which mass testing and proof of negative tests would be required. In most cases, the country also ended the use of quarantine facilities, agreeing to let those infected with mild (or no) symptoms – and their close contacts – isolate themselves in their own homes. Perhaps most importantly, Beijing explicitly prohibited local officials from blocking or locking fire escapes and building exits as a lockdown-enforcement measure.
It’s a troubling tactic that was blamed (without independent confirmation) for 10 fire fatalities in Urumqi that sparked last week’s widespread protests. Policies linked to Xi Jinping’s zero-COVID goal have been blamed for economic woes in China. Also on Wednesday, Chinese customs officials reported that exports in November fell 8.7% (versus expectations of a 2% dip.) November exports also fell beyond expectations, down 10.6% YoY vs. down 6% expected.
Western Europe’s first week with what is essentially an embargo on Russian oil began inauspiciously, with an Arctic blast from Greenland sending temperatures dipping below freezing after an unseasonably warm autumn. The frigid temperatures are boosting demand for natural gas in parts of Europe, an early test of the continent’s readiness for winter without Russian energy. Meanwhile, in what many view as an escalation of the conflict, Ukraine successfully used drones to hit bases in Ryazan and Saratov, about 100 and 300 miles (respectively) into Russian territory from the Ukrainian border.
And finally, it was the end of an era in aviation history this week. Boeing has delivered 1,574 of its 747 jets since the company built the first of this model in 1968. Now, the last one that will ever be produced has rolled off assembly lines in Seattle, set to be delivered next year to cargo and charter carrier Atlas Air Worldwide Holdings.
By the way, we’d like your feedback. How are you enjoying this weekly roundup? We read everything members send and make every effort to write back. Please email thoughts and suggestions to inquiry@fsinsight.com
Important Events
MoM
Est: 0.3% Prior: 0.4%
YoY
Est: 7.3% Prior 7.7%
CPI measures the change over time of a basket of goods and services. Price data for key components like energy and food are reported as well.
Lower Bound
Est: 4.25% Prior: 3.75
Upper Bound
Est: 4.50% Prior: 4.0%
The Federal Open Market Committee will announce its latest decision on the Federal Funds rate. The press conference afterwards will provide details regarding the Fed’s views on the macroeconomic environment.
Est: 0.1% Prior -0.1%
This statistic measures the volume of production of US industries such as factories and manufacturing.
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Stock List Performance
| Strategy | YTD | YTD vs S&P 500 | Inception vs S&P 500 | |
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Sector Allocation
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+11.75%
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+9.21%
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+33.22%
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