What Our Clients Are Talking About Behind The Scenes

The S&P 500 keeps grinding higher despite a fair amount of skepticism from investors, and the continuing slow deterioration in the economic backdrop, both domestic and global, which continues to feed the negative earnings revisions cycle that I have been forecasting for many months. 

The NAHB market index has now fallen for eight straight months and has now achieved its worst streak since the 2007 housing market collapse.  The data release was not only a downside surprise, but also was worse than the most pessimistic forecaster in the Bloomberg survey economists.   In addition, the NY Fed’s Empire State Manufacturing Survey also plummeted well below Street expectations as it posted its 2nd biggest monthly drop on record.   With the release of the UMichigan survey last week that showed falling inflation expectations, the bulls are feeling frisky with the “bad news is good news” interpretation from the economy that will cause the next Fed easing cycle to begin sooner rather than later. 

As has been the case, my medium-term work, as well as my view on the Fed, still does not support the view that the “all-clear” sign has been flashed and we have begun a new bull market following the S&P 500 low in June.  When looking at my key indicators, there is scant evidence that shows that the bounce is unlike any of the double-digit bounces or the other 20% rallies that occurred in both 2000 and 2008 bear markets.  In both of those periods, severe oversold price conditions were reached that led to powerful rallies that ultimately failed as the ASM indicator for the S&P 500, which is my proprietary earnings revisions indicator, kept falling as it is now.

With the S&P 500 now tactically overbought and reaching price levels that are approaching significant overhead technical resistance areas, the index likely needs more fuel to keep the rally going.   So, where is it going to come from?  Yes, there is talk and some work done by certain Wall Street trading desks that are forecasting over $7 billion worth of CTA demand every day over the next week or more, as well as $5+ billion worth of corporate shares buybacks, which if these expectations are accurate will certainly keep providing some additional tailwind for the equity markets.  However, at some point, my research suggests there needs to be more to sustain the positive tone for equities. The two most frequent drivers for sustained upward price action is either, or both, of the following: a) optimism that earnings growth will accelerate in the forward four quarters, and b) a reason to put a higher valuation multiple on those expected profits. 

Based on my key metrics that look at the earnings revisions of the Wall Street analyst community, their forecasts still look too high and likely need to be lowered.  Importantly, not just lowered, but cut at an accelerating rate that likely gets to a level of negativity that will ultimately exceed reality.  So, my work does not support better earnings growth at this time.   When looking at broad market valuation multiple expansion, it is my view the most obvious and powerful catalyst would likely come from an explicit shift to Fed easing not just expectations of slowing the pace of tightening.    It is my view that all of the Fed speakers that have commented after Chair Powell’s post FOMC press conference have made it quite clear that the “Dovish Pivot” is not imminent.  Hence, both my objective quant work and subjective macro thoughts keep me quite skeptical that fuel for the S&P 500 to keep powering higher without a major retracement, if not a new low, is still lacking. 

During client meetings, I have had questions and pushback regarding the fact this rally has been quite hated and that is contrarian bullish.  I empathize with this view, especially if the ASM indicator had already reached max pessimism and I had more conviction that a major Fed easing cycle was on the way like the central bank’s response during 2020, 2009, and 2003.  Furthermore, despite there being some short-term sentiment and positioning polls that show bearishness, which is a contrarian indicator, Bank of America cites their private client data as showing that investors are still overallocated to stocks (66%) versus the historical average (56%), and certainly well above levels seen at either the COVID lows (54%) or the Financial Crisis bottom in 2009 (39%).  So, I am not completely sold how much tailwind is left from excessive bearish although it may not be 100% drained just yet. 

With all that said, my aggressive tactical indicators remain favorable as they have been for most of the rally since June and have neither reached extreme readings nor are showing signs of rolling over, which suggests that there could be some additional tactical upside remaining.   It is beginning to look like the next pullback in the equity market will be a rather big event for investors as they will have to make an important portfolio decision — Will it be a dip to buy or a resumption of the bear market that pulls the S&P 500 down towards 3600-3500, or lower?   As of now, my research is still pointing to the latter. 

Bottom line:  Stay patient.   Use ongoing rally to sell into, raise cash, increase hedges, and reposition towards Growth, both defensive and offensive, and away from Cyclicality.  The opportunity to aggressively pivot towards increasing risk, lowering cash levels, and moving to offense is still in front of us.  

MAIN CLIENT ISSUES

• Last week, I was on vacation and did not have any formal clients calls or meetings.   However, I did have many interactions while I was poolside from folks that still reached out and wanted to discuss things.    
• Clients that are more fundamental/macro driven with a medium/longer-term outlook remain quite skeptical of the ongoing bounce and most are more inclined to sell into the recent strength rather than chase it higher.    
• On the other hand, clients that are more tactical and open to technical analysis have been more willing to play the bounce and chase for more because they can shift to neutral/bearish quite quickly.