Well, we are finally done with 1H22. Phew. I could comment about how bad it was, but I will spare you from reading it again here.
Unfortunately, just because the calendar flipped to a new month, new quarter, and to 2H22 the same headwinds are likely to present challenges for more time. How much longer will this take? How much of the bad news is priced in? I get asked this quite regularly. I also hear “But everyone is already bearish and knows the economy is slowing and sell side earnings forecasts are too high” — so, it must be in equity prices.
I am fully aware of this and being a contrarian am empathetic and trying to use my tools to gauge what is and is not discounted by the market. I am reminded of an exchange I had with a well-known value manager during the summer of 2008 regarding homebuilders, banks, and consumer related stocks. At that time, those areas had been hit very hard and nearly everyone was bearish on them. The bullish argument from the value manager went like this — “The stocks are super cheap, the homebuilders are now selling below book value, and everyone hates these areas more than at any time in my career. They are a contrarian buy.” I countered with — “Yes, everyone hates them, BUT with my ASM indicators still falling at accelerating rates 1) had we reached max pessimism? and 2) are the stocks cheap if earnings/book values are still going lower?” If you remember your history, that didn’t end too well for the value manager in question.
I share this because once again my ASM indicators are falling and max negativity when looking at earnings revisions has not been reached. My works says that this takes TIME. Granted, there are lots of factors that are impacting markets including inflations, Fed policy, and geopolitical events to name a few and maybe my view is too simplistic. However, history has been on my side.
I hope everyone enjoyed a nice long weekend and a Happy 4th to my U.S. readers, with some time away from screens and your regular day to day grind. I look forward to connecting again as we begin the third quarter and navigating what could be both a challenging and potentially rewarding second half (at some point).
MAIN CLIENT ISSUES
- Confusion, Frustration, and Lack of Firm Views
- What’s priced in? Fed? Earnings?
- Dumpster diving. What single stocks might have fallen enough to nibble on?
SPECIFIC CLIENT QUESTIONS
- Where is your S&P 500 earnings revisions index now? Is it still falling?
- What are your updated sector recommendations?
- What sub-industries within cyclicality that are to be avoided/shorted?
MY ANSWERS
- Where is your S&P 500 earnings revisions index now? Is it still falling?
It is clearly below zero and headed lower.
The economic backdrop is showing clear signs of slowing and last week’s data has certainly contributed to growth concerns. The combination of the construction spending data missing expectations, weak ISM readings with forward looking orders metric falling below the key 50 and to its lows point since May 2020, and the Atlanta Fed GDP now tracking estimate falling to a negative 2.1%. Based on my key indicators, analyst’s expectations are going to fall. In my view, this will begin to pick up pace during the earnings preannouncement season that will start this week and continue when companies begin to report 2Q22 results and start lowering their forward outlooks. My work shows that the “E” is quite important, and history shows that ignoring this and thinking things are priced in have not led profitable outcomes.
Bottom line: My work shows that my expected estimate revisions cutting cycle has clearly started but is still in the early innings. Historically, this takes time to play out. Granted, the amount of time can vary depending on many factors, but there is little precedent to expect it to be less than 2-4 more months. And I would be remiss if I didn’t state that it could take longer. I will likely remain cautious until the rate of change reaches its most negative point barring a sudden shift in the oil/Fed situation.
- What are your updated sectors recommendations?
Most preferred sectors are HC, Staples, Tech, Energy, and Utes. Least preferred sectors include CD, Comm Services, Fins, Industrials, and Materials.
There continues to be a fair number of conflicting outlooks between the optimists, who feel that the lows may have occurred or are close, and those that are more concerned about additional downside risks (the view that we still have). To help us derive recommendations, our sector dashboard is quite helpful at presenting our key indicators and visually identifying conclusions. When looking at the summary table below, the one clear takeaway from our perspective remains from the last couple of months — the dominant cyclical sectors, CD, Industrials, and Materials appear to be at risk of underperforming as we look forward 3-6 months. A second signal is that Growth, both offensive (Tech) and defensive (HC and Staples) are relatively looking more attractive. As we stated earlier, this shift may not begin immediately, but our research suggests that over the next 3-6 months there is a high likelihood of this occurring.
Bottom line: The 8-panel analyses that I use for my sector recommendations continue to show relative favorability in traditional defensive areas and increasing deterioration in more cyclical sectors. Importantly, the readings that keep supporting this shift are nowhere near extreme and suggest more is to come before a reversal back to offense is attractive.
- What sub-industries look the most unfavorable and should be avoided/shorted?
Most are cyclically related and are mainly within Materials, Industrials, and Consumer Discretionary.
Two weeks ago, I published a note that addressed this topic of what areas my work was flashing the most unfavorable readings ( Report Link ). During my meetings over the last five days, I had a lot of questions regarding areas to avoid as investors look for outperformance. Thus, I thought it would be still relevant to reiterate that the sub-industries should be avoided/shorted.
A few examples in real time of what is happening and will likely occur even more as we move forward comes from the semiconductor area. First, TSMC announced that it sees major clients cutting their chip orders for the rest of the year. Second, Micron (MU 0.57% ) announced its results and provided disappointing guidance. Just as recently as their mid-May investor day the company was guiding the Street to 7% above consensus on revenue and 10% above on EPS. However, last week MU’s management announced that August quarterly revenue would be 21% below consensus and their EPS a whopping 37% lower than the average Street estimate.
These news events have pressured the semis to be the second worst performer since my note two weeks ago. My research suggests that we are still in the early stages of guidance being lowered by cyclically related areas.
Sub-Industry — Avoid/Short
Materials
Commodity Chemicals, Construction Materials, Aluminum, Div Metals & Mining, and Steel
Industrials
Building Products, Electrical Comp & Equip, Conglomerates, Industrial Machinery, Trading Companies, and Trucking
Consumer Discretionary
Homebuilders, Footwear, Distributors, Department Stores, Apparel, and Specialty Stores
Technology
Semi Chips
Bottom line: My estimate revisions indicators are clearly weakening as I have been discussing for several months. The next areas to start getting hit very hard are cyclically related. Hence, my work signals being below neutral and for relative performance gains start to look to traditional growth areas that I will address this week.
