What Our Clients Are Talking About Behind The Scenes

FLASH COMMENTS:

Based on our work, the post-FOMC meeting equity market rally will likely fail as Chairman Powell’s press conference comments do not change much, and it is our view that future talk and fears of a potential 75bps hike have a high probability of resurfacing.  

The earnings revisions backdrop, which has been one of our key supports for what was our longstanding medium term constructive view, continues to weaken.  First, it was only negative inflections, “less good”, but our key proprietary revisions indicator continues to show broadening deterioration and is heading towards the southern hemisphere and accelerating absolute cuts or “getting worse”.

Our work suggests this combination of a hawkish Fed, elevated inflation, slowing growth, rising interest rates, strong USD, continued geopolitical tensions, and an expected analyst profit cutting cycle is creating significant headwinds for the U.S equity markets.  With risk premiums also rising, we continue to signal caution and if there is a definitive downside price break of 4000 for the S&P 500 we will target 3600-3500.

Bottom line:  Be careful.  Despite the possibility of an oversold tactical bounce at some point during the first half of May, our key indicators are weakening and nowhere near negative extremes at this time, which suggests considerable downside risk remains.  Main positioning points: 

MAIN CLIENT ISSUES

• Fed policy
• How to position?
• What is actually being discounted?

SPECIFIC CLIENT QUESTIONS

• What are the earning revisions showing? 
• Are your fears already priced in as there are some signs of pessimism?
• On a relative basis, does any Sector (GICS L-1) or Sub-Industry (GICS L-4) stand out as favorable?

MY ANSWERS

Q: Did Fed Chairman Powell’s post meeting press conference comments change your view on the Fed being very hawkish? 

NO, not at all.

Based on our work, the post-FOMC meeting equity market rally will likely fail as Chairman Powell’s press conference comments do not change much, and it is our view that future talk and fears of a potential 75bps hike have a high probability of resurfacing. 

We did not interpret the Chairman’s comments as dovish at all.  In fact, we think they were in line with our hawkish Fed thesis that we have been discussing since March.  After several current and past Fed governors commented about wanting tight financial conditions, we find it unlikely that the FOMC wanted their initial hike of 50bps, the first one of this size in over two decades, to be seen as a dovish signal and that an all-clear sign for equity investors was given.  With that being said, a large equity rally may bring out the hawkish Fed speakers again to temper the unwanted bullishness. 

I agree with my colleague, Tom Lee, who stated in his recent note that “tightening financial conditions doesn’t mean that stock markets need to break.”  Importantly, however, we do think that a rising market at this time would not be viewed favorably by the committee.  So, in our view the Fed’s preference is for equity prices to be flat-to-down and that it would likely accompany a soft landing by the U.S. economy.  Well, call us skeptics or pessimists, but we think the probability of them being able to accomplish either will be challenging, and nearly impossible to do both. 

Bottom line:  It is our view that the Fed is in hawkish mode, and that the thinking internally by the committee is that they will be going higher for longer.  Do not underestimate their current resolve to want to hang on to this.  Ultimately, we believe they will likely have to reverse course, but not until a policy mistake has already been made. 

Q: What are the earning revisions showing

There are clear signs of deterioration when looking at the overall market earnings estimate revisions and the weakness is broadening.

During our May FSI Sector Update, we commented that our proprietary earnings revisions work showed clear unfavorable signs.  The weakness was shown by the growing number of second derivatives rollovers or what we refer to as “less bad”.  When this occurs, absolute estimate activity is still positive, but it is losing positive momentum, and that is a clear signal in our methodology. 

Although we are not due for our next deep dive into the broad universe until next week, a review of the S&P 500 this week is clearly showing that the weakness is broadening. There are now signs that our key metrics are still falling, turned to absolute negative, and are starting to pick up some steam.  Based on our historical analysis, this process seems to only be in the early stages. 

It is our view that as we move away from the recent earnings season and now that the Fed has commenced its tightening cycle that negative earnings revisions activity is about to accelerate, especially for sub-industries and specific stocks that are more sensitive to economic cyclicality.

Bottom line:  We have been profit bulls for over two years coming out of the March 2020 COVID low.  Supportive earnings revisions activity was one of our most important supports that kept us bullish until 1Q22.  Importantly, this has turned unfavorable, and the down cycle is just beginning.  What is unclear is whether estimates get slashed in a short period of time similar to 4Q18 or will they bleed lower over a longer period of time.  How this plays out could very well impact the path of equity prices over the next 3-6 months.  Stay tuned.

Q: Are your fears already priced in as there are some signs of pessimism?

Granted, our work shows some of the pessimism signs and acknowledges that a tactical bounce is nearing, but the bigger takeaway is that our work says readings will get worse and that it is not discounted. 

Our shift towards worry, caution, and increasing potential for downside risk has led to many lively interactions with clients about what is and what is not priced into markets.  The more optimistic group makes very compelling arguments.  However, there are parts of my work that suggests there is more pessimism to come and it’s not priced into the market.  To make this case today, we are going to use an example that we discussed in many of our client meetings. 

We have made the comments that all things cyclical are likely to come under pressure because their ASMs would likely be quite negative for the next 1-3 months, at minimum.  Some clients have pushed back and stated that since these stocks are already down a lot on price, and in their view the bad news we are concerned about is already priced in.  We do not agree with this view. 

Let’s take a look at Rockwell Automation (ROK), which is shown on the following page.  

Our view and what we have been showing clients is that the price decline that ROK experienced from December 2021 to March 2022 was the result of the stock being overbought and its ASM rolling over from a positive extreme (see ASM chart below).  Importantly, we have also been pointing out that its ASM had not even gotten to the southern hemisphere yet and its red bars hadn’t even begun to really show up.  

Thus, it is our view that all names like this will see their ASMs fall into the southern hemisphere, red bars will also appear, and this will drive stock prices lower. 

Well, ROK reported its earnings earlier this week (see bberg blurb below).  The company missed, lowered guidance, and the stock got crushed (see bberg chart below). 

Bottom line:  In our view, nearly all stocks that are cyclically sensitive are at risk of something similar and this is one of the main reasons why we do not think that the next down leg in earnings revisions is discounted. This is crucial to why we are forecasting lower equity markets. 

Q: On a relative basis, does any Sector (GICS L-1) or Sub-Industry (GICS L-4) stand out as favorable?

We have been asked quite a bit to forget about any of our macro thoughts and just to use our indicators to show what is looking relatively favorable.  Our main objective/quantitative tools are our proprietary 8-panel analyses and HALO model. 

So, we looked for relative negative extremes in our sub-industry (GICS L-4) work and what is looking “less bad”, which has historically been the set up with high probability of future outperformance.  The sub-industries below were not the only areas that look relatively favorable, but they did stand out the most to us.  An interesting mix to say the least with a clear defensive bias. 

• Specialty Chemicals
• Aerospace & Defense
• Hotels, Resorts & Cruise Lines
• Brewers
• Soft Drinks
• Tobacco
• Managed Care
• Property & Casualty
• Health Care REITs
• Specialized REITs

Fundstrat Global Advisors:  Global Portfolio Strategy — Intro to Methodology