FLASH COMMENTS


In last week’s Whispers, I included a few FLASH points and based on the action in both the equity and fixed income markets over the past week I wanted to reiterate them again. 

There has been a big shift in thinking, commentary, and trading towards this new “hawkish Fed” view. However, in my opinion, there is a fairly high probability that this is being well overdone, and I question if the U.S. central bank has actually turned hawkish. 

  • My work remains medium-term bullish.
  • Buy tactical dips in Financials and Cyclical/Reflation trades.
  • Sell relative strength in defensive areas — Utilities and Health Care.
  • Growth/FAANG remains as tilt above benchmark — have less exposure than pre-4Q20 but note they were never suggested to be abandoned — do not chase any tactical outperformance.

More to come on the supporting evidence.  Stay tuned. 


MAIN CLIENT ISSUES

  • Was the Fed really hawkish? 
  • Surging short interest rates while long yields plummet.
  • The U.S. dollar sharply rising.
  • Violent intra-market rotations.
  • Idiosyncratic discussions went to nearly zero.
  • Sector discussions were quite low as  more folks wanted to discuss allocation topics — Large vs. SMid and Growth vs. Value.    

QUESTIONS AND ANSWERS

Although you are not an official economist or Fed watcher, do you think the Fed was actually hawkish?  What do you think is really going on?

Not surprisingly, the most asked questions for last week were all related to the Fed meeting and then the follow up comments on Friday morning by St. Louis Fed President Bullard, who is currently not a voting member.

I do not make it a habit to make too many deep comments about the Fed and the fixed income market, but since I was asked so much, I felt I would share my views. 

With such a dramatic shift in thinking, commentaries, and market action in several asset classes, I have to say that I am a bit perplexed because it is not clear to me that the Fed has actually turned hawkish.  Maybe I am being stubborn, daft, or just missing something quite obvious.  In discussions that I have had with my preferred network of Fed watchers and Fixed Income economists, which were quite heated, I have come away with the view that the Fed has not turned hawkish

From what I am hearing, a group within the FOMC is hawkish, and they are quite vocal, but they are in the MINORITY. But, importantly, the majority, which will ultimately drive the actual policy by the central bank, remains dovish.  Indeed, Chairman Powell made the following comments during the post-meeting press conference:

About the dot plot, these are of course individual projections.  They are NOT (emphasis mine) a committee forecast.  They are NOT a plan, and we did NOT actually have a discussion of whether liftoff is appropriate at any particular year because discussing liftoff now would be HIGHLY premature.

And the last thing to say is the dots are NOT a great forecaster of future rates moves…So, dots should be taken with a BIG BIG GRAIN OF SALT.

Conditions to see before an adjustment in the target range is made — labor market conditions consistent with maximum employment, inflation at 2% and on track to exceed.

The focus of the committee is the current state of the economy.  But in terms of our tools, it‘s about asset purchases.  That’s what we’re thinking about.  Liftoff is WELL INTO THE FUTURE.  The conditions for liftoff are very far from maximum employment for example.“-Chairman Powell

Well, when I heard and read the transcripts of Chairman Powell’s press conference and then seeing how several asset classes violently shifted, it is my view that something is amiss.

Thus, it is my opinion that the hawkish interpretation of the post-FOMC meeting dots and Fed President Bullard’s Friday morning comments will be walked back by one, or many, of the ongoing dovish majority, which will likely be bullish for equities, Value/Cyclicals/Reflation/Recovery vs. Growth/Defense, and SMid vs. Large. 

The big question is when will it happen?  Unfortunately, I do not have a good high conviction answer at this time.  My network was quite torn, but my most respected source is expecting the mid-July two day Humphrey-Hawkins testimony by Chairman Powell is when this anticipated reversal will occur.   If this is the case, we may be in for some rocky market action.  Critically, until the dovish walk back occurs whether sooner or later, the stock market, as well as the fixed income market and USD could remain volatile and with downside pressure for equities and my preferred investment themes.  So, let us keep our eye on Fed speakers more than usual and there are several on deck for the coming week. 

Bottom line:  It is my view that recent hawkish fears that have impacted equities, styles, and sectors is a short-term development and will be FULLY reversed.  NO portfolio shifts are recommended at this time, and investors should use countertrend, relative performance price action to continue to rotate into our main preferred positioning — Cyclicals/Value/Reopening, SMid over Large, and Fins/Industrials/Materials/Energy over Staples/HC/Utilities. 

With long rates falling, the greenback up, and a violent intra-market rotation for equities, have you seen any significant changes to the earnings revision backdrop that would suggest investors should be making drastic positioning changes?

NO, as I have stated several times over the last several months the revision data has been quite stable and is still flashing the same main messages:

  • Constructive and supports additional equity market gains.
  • Offense still relatively favorable versus defense and NOT yet extreme.
  • Cyclical/Reopening/Epicenter looks relatively better than Secular Growth.

Bottom line:  From a 3-6 month perspective, our earnings revision based process is still supporting our longstanding positioning recommendations — Cyclicals/Value/Reopening, SMid over Large, and Fins/Industrials/Materials/Energy over Staples/HC/Utilities. 

What are your aggressive tactical indicators signaling now?

Flipped to unfavorable on Thursday.  My key aggressive tactical indicators — HALO-2, and V-squared (see explanations at the end of the note) — have rolled over and are not yet extreme or showing signs of positively inflecting as of Friday’s close.  Hence, there may be additional tactical downside for the S&P 500 until these indicators shows signs of bottoming.  However, I am on the lookout for upturns that will shift my tactical views back to favorable. 

Bottom line:  There may be some additional downside pressure on the S&P 500, but if there is a further move lower I will view it as a tactical dip that should be bought. 

Flipped to unfavorable on Thursday.  My key aggressive tactical indicators — HALO-2, and V-squared (see explanations at the end of the note) — have rolled over and are not yet extreme or showing signs of positively inflecting as of Friday’s close.  Hence, there may be additional tactical downside for the S&P 500 until these indicators shows signs of bottoming.  However, I am on the lookout for upturns that will shift my tactical views back to favorable. 

Bottom line:  There may be some additional downside pressure on the S&P 500, but if there is a further move lower I will view it as a tactical dip that should be bought. 

What Our Clients Are Talking About Behind The Scenes

Bottom line:  It is my view that the Fed did NOT turn hawkish last week.  Hence, the extreme action that occurred in the stock and fixed income markets, as well as the violent intra-market rotations that occurred in equities are all overdone and creating opportunities for investors, especially in my ongoing portfolio themes — Value/Cyclicals over Growth/FAANG, and SMid over Large— and preferred sector positioning — Financials, Industrials, and Materials as Full Above Benchmark and HC, Staples, Utilities, and Real Estate as Full Below Benchmark. 

Not only do I feel strongly that the recent hawkish shift by markets and forecasters will be completely walked back by Chairman Powell and the doves in the weeks to come, but importantly my key indicators remain quite supportive for more upside potential for the S&P 500. 

Long time subscribers should not have been surprised by the recent market volatility as I have been warning since the end of 1Q21 that it was likely to occur.  I remind readers from time to time that if/when periods like this happen, that having a disciplined investment process is invaluable and limits the temptation to give into emotion and day-to-day market action and headline news. 

With that being said, until the FOMC’s ongoing dovish message is fully reestablished, there could be some further choppy to downside risk in the S&P 500.  However, as we approach mid-July and the beginning of the 2Q21 earnings reporting season, my research strongly suggests that the combination of an accommodative monetary policy and strong corporate profits will drive the next leg higher in the U.S. equity market.  So, let us not fear any volatility and not get shaken out of our positions, but instead confidently try to take advantage of the market action as we keep focused on the bigger picture. 

The U.S. economy is on the path towards nationally reopening and each day takes us further down this path towards returning to pre-COVID levels.  Unquestionably, this has been and remains an important component that underlies my continuing bullish equity market outlook, and I still see normalization as a valuable piece of evidence that should help fuel the continuation of the ongoing equity market rally. 

Thus, I do not have any major changes, and my ongoing mantra of STAY THE COURSE is still valid.  Even though there are still elevated levels of unease among institutional investors my analysis portends that the U.S. equity market will keep trying to navigate the “Wall of Worry.”  And if we get some additional relative weakness in the sectors/stocks that are favorable in my investment process, we raise exposure and avoid or trim the areas that still remain unfavorable. 


Definitions of HALO, HALO-2, and V-squared

HALO = The proprietary Fundstrat Portfolio Strategy Halo Model is a multi-factor model that attempts to predict the forward 1 – 6 month relative performance of a group.  The goal is to help both strategic accounts better time their implementation strategies that would be consistent with our more strategic conclusions derived by our sector/sub-industry 8-panels as well as our stock specific Estimate Revisions Model (ERM), and to generate tactical ideas for aggressive trading accounts. 

HALO-2 = The proprietary Fundstrat Portfolio Strategy HALO-2 Model is the raw tactical data behind our standard HALO multi-factor model described on the previous page.  It is useful for identifying aggressive tactical trading bottoms for the S&P 500.   

V-squared = The proprietary Fundstrat Portfolio Strategy V-squared indicator at its lowest level shows the ratio of VXV (the 3-month CBOE S&P 500 Volatility Index) and the VIX (the 1-month CBOE S&P 500 Volatility Index).  This tool is also useful for identifying aggressive tactical trading bottoms for the S&P 500.  

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