Our Views
Solid start to June but Fed FOMC decision is key
The S&P 500 is up 10% YTD (after the first five months) and many investors simply “sat this out” — on the sidelines, given multiple overlapping uncertainties.
- Equities have been rising now for 8 months and if stocks rise again in June, that would be 9 months of gains — meaning, the rally since October 12, 2022 is longer than the 9 month drawdown -27%. This arguably further confirms that October 12, 2022 was likely the end of the bear market. A new bull market has been underway, in our view.
- 2023 is tracking with our baseline view that the highest probability is the S&P 500 will gain >20% this year, reflecting a positive combination of Fed relenting (pause/done), EPS troughing and the associated valuation expansion seen at the start of the new cycle. And with 7 months left, the S&P 500 is tracking for ~25% gain, inline with our YE target of 4,750.
- The primary likely catalyst remains that inflationary pressures ease faster than consensus and Fed expect. For many this looks like a tall order, as many suggest inflation is now firmly entrenched in services inflation. But as we noted previously, PCE core services inflation has a 15% weight in Financial Services, thus, Fed hikes are contributing to the rise in PCE core services itself.
- The May ISM manufacturing report brought mostly good news. The headline PMI came inline at 46.9 vs 47.0 consensus and 47.1 last month. But the “prices paid” surprised to the downside coming in at 44.2 vs 52.3 Consensus and 53.2 last month. The monthly drop of -9 is the largest since July 2022. So a sizable cooling in inflationary pressures and again, supporting a Fed pause in June. The May employment report (Friday 8:30am ET) will be particularly telling, but the key is average hourly earnings 4.4% or better.
- Lastly, JPMorgan’s Flows and Liquidity Team (flagged by @CarlQuintanilla) reported a sizable inflow into Technology ETF funds this past week. Retail investors are responding to the outperformance of Technology stocks. But this is good news. There remains a lot of retail cash on the sidelines and this firepower will eventually be invested. We think a lot goes into equities.
- Institutional investors apparently remain skeptical. The latest COT (commitment of traders) show speculative short of S&P 500 futures is now -17%, the highest level in 16 years. This is despite fundamental drivers supporting higher equity prices. Again, this speaks to the widespread skepticism.
- And this skepticism also reflects the widely held view that the US is going to eventually tip into a recession. But a recession is a sudden and unexpected downturn in economic activity evidenced by falling employment, activity and inventory. But the rapid Fed hikes and the expected slowdown was well telegraphed by Fed last year. Thus, we think much of the contractionary impacts have already been felt.
BOTTOM LINE: June FOMC key this month, and sticking with FAANG OW
- The beginning of the week unfolded much like the last month, with Tech/AI related names powering the S&P 500 cap-weighted index higher while the broader equity indexes (S&P 500 equal-weighted and Russell 2000) stayed in the red. However, a powerful combination of events drove equities higher.
- The debt-ceiling debate quickly came to an end to keep the U.S. from a default, a handful of Fed speakers communicated their willingness to skip raising rates at their upcoming June meeting, and the macro data releases showed that the domestic economy is still growing and the oft-forecasted recession is still not in view. All in all, nearly every favorable box was checked this week.
- The Fed meeting is about two weeks away, but if they are indeed willing to “skip” June and evaluate how the tightenings over the past 16 months are impacting the economy, there would likely be more headway for the equity markets to rise as the fears for recession and lower future earnings would likely fall. My work still suggests that there are still challenges out there, but they may get pushed out, allowing equities to keep moving higher for now.
Based on my research, I am still advising a barbell portfolio positioning that is made up of both defense and Large Cap, Higher Quality, Secular Growth areas. My key indicators are still unfavorable for Smid, Low Quality, and more cyclically related areas, which reflects the positioning that I have been recommending since my February sector update, where I took my uber bearish scenario off the table, suggested tightening exposures, while downgrading Energy, HC, and Staples, while upgrading Tech and communication Services.
- Examining the relationship between PMI data and Bitcoin (BTC) prices, we find that BTC tends to bottom out before PMI and often tops out before PMI reaches its peak. This suggests BTC acts as a leading indicator. Excess liquidity can sustain BTC’s bull market despite declining economic activity. Therefore, while short-term volatility is expected, historical data contradicts the idea of BTC reaching new lows based on recessionary indicators.
- The forthcoming debt ceiling agreement will assuage default concerns but is expected to introduce approximately $1 trillion in treasury supply to the market. Analysis of past TGA refills indicates a potential negative impact on BTC prices. However, the combination of a declining RRP balance, global monetary easing, and a pause in rate hikes suggest that any downside volatility is likely to be short-lived.
- While we remain unconvinced about the value proposition of XRP, we believe a victory over the SEC would undoubtedly be perceived as a triumph for the entire industry, countering what is widely seen as an overreaching regulatory body. Despite the potentially limited scope of such a ruling, it is probable that XRP would experience a rally, and other altcoins would also reap the benefits from a successful outcome for Ripple.
- Trade Idea Update: LTC has shown strong performance recently, attracting trader interest ahead of its upcoming halving event. Despite a temporary setback caused by the SVB calamity, LTC has fully recovered. The trade continues to hold promise, and clients can expect additional technical updates in the coming weeks.
- Core Strategy: Despite our recommendation in late April to raise cash in anticipation of a near-term resolution to the debt ceiling (TGA refill = lower market liquidity) and recent negative price movements, our overall outlook for the year remains positive. If the Federal Reserve follows through with a pause, it would be a positive development for assets sensitive to liquidity conditions.
- House and Senate pass resolution to debt-ceiling issue, with legislation to go through mandatory “engrossment” before heading to the Oval Office.
- Debt ceiling will be suspended until after 2024 elections, and Republicans win concessions on energy, tax, welfare, and spending-cap issues.
- The bill does not preclude additional spending for emergencies such as natural disasters, national security, or assistance to Ukraine.
Wall Street Debrief — Weekly Roundup
Key Takeaways
- The S&P 500 rose 1.83% to 4,282.37 this week. The Nasdaq climbed to 13,240.77, up 2.04%, and bitcoin slipped 2.92% to 27,253.80.
- Tom Lee explains why stocks could have another 10% upside this year.
- Our Brian Rauscher weighs in on what’s to come for Tech.
“Software is eating the world, but AI is going to eat software.” ~ Nvidia CEO Jensen Huang, 2017
Good evening:
At the start of the year, pundits and experts were skeptical when our own Tom Lee predicted the S&P 500 would break 4,200 before revisiting the all-time high by year-end. Yet stocks, powered by technology, have risen thus far in 2023. By Memorial Day, the S&P had already hit 4,200. Check.
That strength continued in this shortened trading week as markets followed Washington’s progress on resolving the debt-ceiling issue. On Friday, jobs data supplied enough positive news to help stocks close the week strongly. The economy added 339,000 non-farm jobs, far more than the 195,000 economists expected, but unemployment rose to 3.7% (vs. expectations of 3.5%). Perhaps more importantly, average hourly wages decelerated. As Lee notes, “In fact, 83% of industries had a deceleration of wage growth.” Combined, that appears to have been enough evidence of a cooling labor market to temper the market’s fears of another Fed hike in June, while also further supporting the view that we are headed for a soft landing.
Now, the question becomes: How much further upside is left in 2023? Technology, Lee’s top sector since December, has been the clear leader, and we believe there’s still money to be made in the market over the next seven months, particularly with mega-cap tech.
Despite his view that the rest of the market remains challenging, Brian Rauscher, our Head of Global Portfolio Strategy and Asset Allocation, is in agreement on Tech’s prospects. “When I look at my Sector work, Tech is still strong. Even though I personally don’t like to chase momentum, my work still says that any dip in Tech right now is likely a dip to buy,” he said at our weekly huddle.
“There are some reasons for stocks to advance probably another 10% at least to year-end to get toward the old highs,” Lee said this week. “First, I do think inflationary pressures, even though it’s a mixed picture, are really in a sustained path downward. We’re getting sort of like fluky data, but this week the used car data really pointed to inflation cooling. That’s a huge weight of the CPI.”
Other key takeaways and notes from Lee this week:
The main thing: “The main thing we’re watching for and continue to watch for is that we do think inflationary pressures are diminishing faster than many appreciate, especially consensus and the Fed. While we’re seeing it in the surveys, the soft data, or even used car prices, it’s not showing up in CPI yet. So that’s going to be important to see.”
All eyes on the Fed: “A lot of this upside in the second half can come the Fed realizing that inflation (is) improving and they don’t have to continue to raise rates aggressively. That’s really the primary reason we think stocks can do well in the second half.”
On positioning and sentiment: “Sentiment is still pretty negative, and there’s a ton of cash on the sidelines. So I think there’s a positioning argument that’s still supportive of stocks. If we look at short positioning based on COT, we see the highest net shorts since 2007.”
This is illustrated by our data-science strategist Matt Cerminaro in our Chart of the Week:
On concerns over the AI trade being overcrowded: “Keep in mind, Nvidia (NVDA 1.39% ) wasn’t even heavily shorted into their earnings print when they revised their forecast, and look at how the stock moved in response. […] AI is something the Fed would like to see continue to actually expand because that contains inflationary pressure. If you think about the Fed being hawkish and what they’re worried about, they’re not really worried about AI growing because AI takes away inflation pressures. I almost think that the Fed doesn’t mind that FAANG stocks are rising. Stocks like Netflix and even Amazon, which have been the tail end of the FAANG, are also parts of the FAANG that could really start to pick up.”
On breadth: “Fundamental investors are going to start to become a little constructive because when you look at earnings revisions, they have bottomed, not just tech-only, but rest of the market. When we look at things like technicals, such as 20-day or 200-day, more stocks are starting to participate. So even though breadth hasn’t been great, I think there’s now a chance for investors to say there’s a catch-up trade coming.”
In the coming weeks: While Lee still believes technology is the best place to be in 2023, his team will provide other areas that might join the market rally this summer. He believes breadth expansion could come via financials, discretionary, industrials, or automobiles. Large-cap tech was first to peak in 2021, first to bottom in 2022, and now they’re leading by far, up nearly 50% YTD. “I think the second half is a story of a lot of other sectors catching a bid,” Lee said.
Elsewhere
State Farm announced that it would stop selling new homeowners’ insurance anywhere in California, citing the heightened risk of natural disasters such as wildfires. Insurance trepidation about California echoes the industry’s views on Florida, as hurricane and flooding risks have driven many insurers from the Everglade State.
The Center for AI Safety warned that unchecked AI development could heighten the “risk of extinction” of the human race, releasing a letter signed by OpenAI CEO Sam Altman, the “godfather of AI” Geoffrey Hinton, leading AI research academics, and top AI executives and scientists from Google, Anthropic, Microsoft, and others. The AI experts warn that the potential risks posed by AI are on par with those of nuclear war and global pandemics.
The municipal government of Wuhan, China has been forced to call in its debts, a rare action that comes in the face of its own precarious financial situation in the aftermath of costs incurred because of Xi Jinping’s yearslong zero-COVID policies and recent real-estate crashes. Wuhan is not alone – many large Chinese cities are facing similar financial difficulties.
The Netherlands have restructured the country’s pension system in response to its aging population, allowing private pension funds to offer defined contribution benefits (based on a combination of market performance and the amount the beneficiary contributed into the plan), rather than a pension-style defined benefit plan. The new rules will become mandatory in 2028.
Chinese factory output contracted to a five-month PMI low of 48.8 in May, missing expectations and leading to worries that the post-lockdown reopening bounce was over and that China’s economy is in trouble.
And finally: Psammophile. That’s the word with which Dev Shah, an eighth-grader from Largo, Florida, won the Scripps National Spelling Bee, along with a $50,000 cash prize. For those curious, a psammophile is any organism, plant or animal, that thrives in sandy areas.
By the way, we’d like your feedback. How are you enjoying this weekly roundup? We read everything our members send and make every effort to write back. Please email thoughts and suggestions to inquiry@fsinsight.com
Important Events
Est.: 55.1 Prev.: 55.1
The S&P’s measure of non-manufacturing economic activity.
Est.: 52.5 Prev.: 51.9
A measure of activity in non-manufacturing sectors, based on a survey of purchasing managers.
Prev.: 225.9
The Manheim Used Vehicle Value Index (MUVVI) is an indicator of pricing trends in the used vehicle market, adjusted for a mix of vehicle classes, mileage, and seasonality.
FS Insight Media
Stock List Performance
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Sector Allocation
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+11.75%
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-4.16%
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+0.90%
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