Our research, which has been developed over two decades of Wall Street experience, strongly suggests that our Dunks Product can add significant value by supplementing the actively managed part of your portfolio. By highlighting individual stocks with high-quality reward risk ratios that over the medium/long-term it is possible to raise the probability of outperforming the overall equity market without taking on excessive amounts of risk.
For those who are less risk-averse, we also present some higher-risk, but often higher-reward opportunities that will be included in the Mid-Range Jumper section of the overall Dunks. Both these stock lists are derived by the models and techniques that we have been producing for professional institutional investors since the 1990s. For the first time ever, I am now making it available to retail investors on FSInsight.com.
Our investment and selection methodologies are grounded in proprietary quantitative analysis and methods that have not only stood the test of time but also have been evolving. Please be aware that, because we are using a quantitative model-based method, we are not doing extensive fundamental and catalyst analysis on the individual names we land on. You should always do additional due diligence before adding a name to your portfolio to ensure it conforms with your individual risk tolerance and investment goals.
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Market Commentary
The S&P 500 has had quite a January. For me, the price action was impressive, unexpected, and puzzling all at the same time. Yes, coming into the year following the weak December index performance, a tactical oversold bounce would not have been too surprising.
The data that was released during the month continued to show inflation’s decline and kept the downward trend in place. The combination of three strong Treasury auctions this week (2yr, 5yr, and 7yr) that occurred this past week has begun to increase dovish Fed hopes for their important 2/1 meeting. In fact, the fixed income market is now pricing in two 25bps easings during 2023 beginning in June and over 100bps of additional accommodation during 2024. This increase in optimism has also caused a dramatic loosening of financial conditions. The combination of these two factors normally creates a bullish cocktail for equities, and the S&P 500 has indeed reacted quite favorably, moving up towards 4100, which has reenergized the bulls and tortured the bears. As I have had a less than favorable outlook for a while, the pressure clearly shifts my way to justify why one should remain cautious and not chase the current rally.
The bullish view is generally built upon the assumption that inflation continues its decline and will easily head toward the Fed’s target rate of 2%, which allows Chair Powell and Gang to declare victory in the fight against inflation. Effectively, this allows the FOMC to first stop its tightening cycle and possibly move toward a new easing stance, which would likely provide tailwinds to both the expectations for corporate profits and an expansion in valuation multiples. Although the consensus is moving towards this view, my research suggests that the probability of it playing out is still low. However, if it became clearer that this scenario is a high probability, I will have to consider a more favorable equity market outlook and less defensive positioning.
The bearish outlook that I have had since the beginning of 2Q22 has had two main points, which are:
- the Fed is higher for longer and
- Forward profit expectations are too high, they need to be lowered, and they have not been completely discounted by the market (i.e., THEY MATTER — A LOT).
Additionally within #1 is that, although I agree that the peak in inflation has already occurred, future improvements will be a hard fight, which leads to Chair Powell and Gang needing to keep methodically raising rates to at least 5.25%-6.0% and also keeping the final stop unchanged well into 2024. Thus, to put it another way, the bar for the Fed to return to an easing stance is set quite high and less likely than what is priced into the fixed income markets.
So, investors are faced with two outcomes that are almost diametrically opposed. It is not easy to decide what is the best path to take. My perspective, which may differ from my colleagues, is that each individual needs to assess their own respective risk tolerances and ask themselves the following question:
What would cause you more distress and pain –
- Underperforming in the face of an S&P 500 rally, or
- Having a significant drawdown after the S&P falls to 3200-3000?
If it is number #1, then one could be more bullish and begin putting money back to work. In this outcome, if the equity market does fall instead of strongly rising, you can either just sell and take a loss, or hold on until after the ultimate bottom is made. However, if number two is closer to you, then I would advise remaining patient, which would limit your downside risk while possibly trimming upside potential if markets have already made their lows in October. If my base case bear scenario plays out, then you will be in good shape to put money to work once the final trough is in place.
Based on my work and the assumptions below, I continue to advise caution as I see considerable risk still present. I remain on alert for my indicators flipping to back to a bullish stance and for my view on the path monetary policy to become more dovish.
The below are my update macro/market assumptions and thoughts:
- The first quarter is likely to see a tug of war each month as the inflation data will likely show continued declines that will fuel the hopes of the optimistic doves only to get a dose of hawkishness because of labor market resilience. While this is going on, the expectations for forward profits will be under downward pressure.
- My research continues to suggest that the battle with inflation is headed in the right direction, but as year-over-year readings fall, continued declines will get more challenging – something that is not fully appreciated by investors. This, combined with the absence of definitive weakening in the labor market, is why I continue to see the Fed path as higher for longer and still am targeting 5.25-6.0% as the most likely terminal rate with a high bar for flipping back to accommodation.
- In my view, earnings revisions and forward profit expectations matter. A LOT. Yes, other factors including falling inflation, a shift in Fed reaction function, and falling VIX are also important, but do not underestimate the signaling of my ASM indicator for the overall market, as it has bottomed BEFORE every major bottom since 1990. Ignoring this will likely not lead to an optimal outcome.
- Valuation multiples are still too high and need further adjustments before equities become compelling again.
- Based on this, I am still advising clients to be careful, cautious, and patient as considerable risk remains.
Bottom line: My work continues to signal danger.
The U.S. equity continues move higher and was fueled by strong Treasury auctions that bolstered growing bullish sentiments that the Fed is going dovish next week. The onus has certainly shifted from the doves/bulls to the hawks/bears.
Will the Fed follow these market expectations, or will the market get hit with a big blast of cold water by Chair Powell and Gang? I expect a 25bps rise in the funds rate, and hawkish commentary during the post meeting press conference that defies the doves and will likely communicate more work needs to be done to win the inflation fight and that the markets need to temper their expectations for a return to accommodation.
Regardless of the outcome of the FOMC meeting, the corporate profit backdrop continues to weaken as domestic growth is set to slow, and the forward guidance being provided during the ongoing earnings season showed that the sequential deterioration has not ended. Hence, my indicators are still suggesting that forward earnings projections are still too high and will need to be revised lower. Importantly, my analysis shows that additional negative earnings revisions are not yet fully discounted.
At the risk of missing a major shift in Fed policy and the start of a new powerful bull market, my analysis continues to signal that the current equity market bounce is a countertrend bear rally that will ultimately fail. Furthermore, my research and view of the macro environment is still looking for the S&P 500 to revisit the October lows, and there remains a high probability of making new lows. My longstanding downside target forecast stays at 3200-3000.
Thus, I continue to advise caution and that investors remain patient while they use rallies to raise cash, reposition, increase hedges, and increase shorts because the road ahead is both windy and full of potholes. For investors that need to be fully invested or want to focus on relative performance, my work continues to show that a barbell approach of Defensive non-cyclicals and some select Secular Growth names will have the most relative winners going forward, as more cyclical related areas will get the brunt of the downward estimate cuts over the next 3-6 months. For cyclicals, I still recommend single stocks to outperform other cyclicals for your exposure. Most of them are higher quality, as poor operators and management teams will likely not have any get-out-of-jail-free cards coming from any new stimulus for quite some time.
Changes this month
There are no additions or removals this month.
Summary
Play: consider increasing exposure
| DUNKS | ||
| SBUX | Starbucks | |
| FANG | Diamondback Energy | |
| CPB | Campbell Soup | |
| RTX | Raytheon | |
| MNST | Monster Beverage Corp. | |
| MID-RANGE JUMPERS | ||
| PM | Phillip Morris | |
| TPX | Tempur Sealy Intl. | |
| ISRG | Intuitive Surgical | |
| COST | Costco Wholesale | |
| AMT | American Tower |
Hold: consider keeping and not adding exposure
| GM | General Motors Company | |
| AMZN | Amazon | |
| CCJ | Cameco Corp. |
Analysis
Dunks
$SBUX – Starbucks
ASM Indicator: It continues to be above the important zero level and remains in its uptrend. Importantly, it is not at peak levels and still has room to move up more. Also, SBUX’s bars have remained green and are slowly trying to get larger. The mixture of these factors strongly indicates that the company has a strong tailwind towards additional outperformance.
Brian’s Take: SBUX has been a solid outperform since being returned to the starting lineup of the Dunks List in December. The combination of its key indicators continues to make a persuasive case that the company is likely to be a strong relative performer during 1H23. I reiterate the view that any tactical weakness be used as an opportunity to raise exposure.
Commentary: SBUX is one of the most geographically diversified Consumer Discretionary stocks, and its deep penetration and considerable pricing power should boost its operating results as economies reopen and move towards normalization.
MNST -1.78% – Monster Beverage Corp. ( PLAY )
ASM Indicator: The key indicator for MNST is still moving higher and is not yet near an extreme level. Moreover, another favorable development supporting the stock is that its bars have bullishly flipped to green, which I expected in my last update. This should provide an additional tailwind to relative performance gains for the next couple of quarters, at minimum.
Brian’s Take: MNST continues to display a positive collection of indicators, as well as a supportive technical setup based on my proprietary tools. The stock has been roughly a market performer since its inclusion in November, but my research strongly points to outperformance during 1H23.
Commentary: Monster Beverage Corp. is a holding company, which engages in the development, marketing, sale, and distribution of energy drink beverages and concentrates. It operates through the following segments: Monster Energy Drinks, Strategic Brands, and Other.
FANG 0.58% – Diamondback Energy ( PLAY )
ASM Indicator: FANG’s key indicator has struggled somewhat and thus remains on my potential downgrade list, but I am willing to give it the benefit of the doubt for now. Over the next several months, a clear shift back to favorable will be needed to keep it on the Dunk’s List.
Brian’s Take: Since Energy’s most recent relative sector performance peaked in early November, most names within the space continue to consolidate. The process looks to be nearing completion, which should likely lead to some outperformance for FANG.
Commentary: This is a well-managed Energy name that should be able to outperform markets and peers and has a tailwind of being in an attractively valued sector.
RTX 0.86% – Raytheon ( PLAY )
ASM Indicator: It continues its attempt to begin a new up cycle by being “less bad”, and the bars for RTX are also ready to begin shrinking during the coming months. If these expectations unfold, the stock would have strong tailwinds for outperformance during 1H23.
Brian’s Take: RTX came into the year relatively overbought and it was overdue for a consolidation, which occurred during January. On an absolute basis, the stock has been flat and looks poised for its next up leg. Its key metrics continue to portend a favorable reward risk set up for RTX for relative gains for the next 12-18 months.
Commentary: Raytheon operates as an aircraft manufacturing company as well as a leading defense contractor. Thus, RTX has a diversified mix of commercial aerospace and military exposure and has been increasing its global exposure as well.
CPB 0.57% – Campbell Soup ( PLAY )
ASM Indicator: The key indicator for CPB is still nicely rising, but it is now approaching the positive extreme zone where it will need to be monitored. The company’s bars are green and slowly getting bigger, supporting the favorable ASM reading. The combination of these has historically led to performance gains in the subsequent quarters.
Brian’s Take: CPB was a strong absolute and relative performer into its recent December peak, where it reached overbought levels. Thus, the stock was over overdue for a consolidation/pullback. That being said, with the shift to laggards and more offensive areas during January, CPB has been hit quite hard and given back a good portion of its outperformance. The stock now looks to be tactically oversold, it held its important support level, and its indicators remain quite supportive. Also, investors have been getting nearly a 3% dividend, which has helped cushion the recent bout of price weakness. I recommend staying the course with CPB during 1H23, as I am still concerned about overall equity market risk. Importantly as we look forward, at some point when I become more constructive, the stock will likely become a source of funds.
Commentary: The company manufactures and markets food products and has two major segments — Americas Simple Meals & Beverages, which includes its retail/food service business as well as its flagship brands like Campbell’s condensed soups, Swanson stocks and broth, Prego Pasta sauce and V8 juices. The second major segment is Global Biscuits & Snacks, which includes flagship brands like Goldfish crackers and Milano cookies.
Mid-Range Jumpers
TPX 2.35% – Tempur Sealy International ( PLAY )
ASM Indicator: TPX’s key metric is slowly beginning a new uptrend, but it is still quite early. Its red bars are showing more definitive improvements as they have been getting smaller for nearly two quarters. The contrarian bullish readings suggest that the stock is ready for additional upside performance gains.
Brian’s Take: The company’s strong price performance since being included in August has it atop the leaderboard of best performers. TPX may get to a full tactical overbought condition in the coming months, but any tactical weakness should be viewed as an opportunity to raise exposure.
Commentary: Tempur Sealy International is a leading designer, manufacturer, distributor, and retailer of bedding products comprised of both traditional innerspring mattresses and non-innerspring mattresses. Its Tempur, Tempur-Pedic, Sealy, and Stearns & Foster brands are sold in 100-plus countries through retailers such as furniture and department stores, online, wholesale clubs, and through third-party distributors. The US accounts for about 75% of Tempur Sealy’s revenue.
PM 0.39% – Phillip Morris ( PLAY )
ASM Indicator: Both the key indicator for PM, as well as its bars, have shifted to favorable and are nicely rising. This dual shift has historically been a strong precursor to healthy performance gains in the subsequent quarters.
Brian’s Take: Being a more stable defensive stock like CPB, PM has had a relative consolidation from overbought levels during January. With the stock still providing countercyclical exposure with an attractive dividend yield near 5%, the positive indicator set up continues to flag the stock as attractive so I would use any additional relative underperformance as an opportunity to raise exposure.
Commentary: Phillip-Morris is the third-leading producer of tobacco products. The company has an 11.4% global market share and owns flagship brands such as Marlboro. In addition, PM is also launching an effort into less-harmful, heated tobacco products. This push has been largely unaffected by COVID and is expected to compensate for the declining global sales of cigarettes and tobacco bans.
ISRG 0.59% – Intuitive Surgical ( PLAY )
ASM Indicator: Its key indicator continues to stair step higher while its bars shrink and are about to flip back to green. The historical tendency is for ISRG to begin a strong outperformance run once both metrics are flashing favorable signals.
Brian’s Take: The company has struggled since its earnings report this past week when it did not announce a new product release for 2023, which disappointed some investors. However, the company is still well positioned, and despite the company’s comments, my sources still think the probability for a new product remain high, which would now be a positive surprise. Although ISRG has not been a stellar performer, my work says let’s remain patient on this one and we have a high probability of being rewarded over time.
Commentary: The Health Care sector is experiencing healthy disruptions and changes, and ISRG is one of the leading innovators in the space. The firm has products that utilize both robotics and augmented reality to positively impact the industry and get improved results for patients.
COST 1.47% – Costco Wholesale ( PLAY )
ASM Indicator: COST’s key indicator looks poised to positively inflect, which would be an important contrarian bullish signal. Its red bars remain small and are attempting to flip to green. If this does indeed occur as expected, the move to the northern hemisphere would strongly confirm a potential new up-earnings revision cycle and increase the likelihood of performance gains during 1H23.
Brian’s Take: The stock has struggled since its inclusion on the Dunk’s List, but due to the strong probability of a new earnings cycle about to begin, COST is offering investors an excellent opportunity to raise exposure before it begins a strong performance run.
Commentary: Costco Wholesale Corporation is a membership warehouse club and sells all kinds of food, automotive supplies, toys, hardware, sporting goods, jewelry, electronics, apparel, health, and beauty aids, as well as other goods. COST serves customers worldwide. As they have over 800 membership warehouse stores, the company is the nation’s largest wholesale club operator. Primarily under the Costco Wholesale banner, it serves more than 111 million cardholders in some 45 US states, Washington, DC, and Puerto Rico, and about 10 other countries. The company carries an average of approximately 4,000 active stock keeping units (SKUs) per warehouse in its core warehouse business, significantly less than other broadline retailers (many in bulk packaging), ranging from alcoholic beverages and appliances to fresh food, pharmaceuticals, and tires. Certain club memberships also offer products and services, such as car and home insurance, real estate services, and travel packages. Costco generates most of its sales in the US.
AMT -0.90% – American Tower ( PLAY )
ASM Indicator: Its ASM indicator has stalled near the zero line while its red bars are getting smaller, which is a favorable signal. I will give AMT the benefit of the doubt for now, but will put it on my watch list for a possible downgrade.
Brian’s Take: The stock continues to struggle on both an absolute and relative basis, but because of its nearly 3% dividend yield and my ongoing concerns about the overall equity market, I am going to stick with the stock for now and start looking for a suitable replacement in the coming months.
Commentary: American Tower (AMT -0.90% ) is now the largest REIT in the S&P 500 and specializes in leasing multi-tenant properties for wireless providers. It has a real estate portfolio of over 200,000 communications properties. It is heavily exposed to fast growing 5G in domestic and foreign markets. It has steady dividends and has proven itself to be a quality compounder over time with secure revenue and above-average pricing.
Holds
CCJ -1.39% GM 0.49% AMZN 1.41% (HOLD)
AMZN, CCJ and GM, which are holdovers in the Hold bucket, will continue to stay there for now. (The “HOLD” bucket is one where a name is not completely kicked out. Longer-term investors with enough funds to keep holding these names and still able to buy our replacement picks may be well served to do so.)
