What Our Clients Are Talking About Behind The Scenes

FLASH COMMENTS:

Well, here we go again. 

The S&P 500 has begun another tactical oversold bounce after holding the 3900ish technical support level.  The U.S. Dollar also appears to have stalled after reaching an overbought condition, and lots of forecasters and talking heads are talking about excessive levels of pessimism, which has energized the bulls who were a bit beaten up since Jackson Hole. 

On the way down from the recent August 16^th peak, the worst performing sectors were Tech, Comm Serv, Consumer Discretionary, and Materials with Energy, Utilities, and Staples the best.  Want to guess what the leaders/laggards have been since the market bottom last week?  Leaders have been Consumer Discretionary, Materials, and Comm Serv among the top five while the laggards have been Energy, Staples, and Utilities in the bottom five.  So, a near-perfect mirror image.  Indeed, the most shorted basket of names as calculated by Bloomberg has surged nearly 12% since Tuesday’s close. 

New bull market or short squeeze?  Based on my work that has been unfavorable since April, the answer remains quite clear — countertrend short squeeze rally. 

After speaking with many clients last week and continuing to have heated internal debates here at Fundstrat, several questions are important for investors to have a view on: 

• Buy this dip because the S&P 500 bottom has already occurred in June, or Sell this rally because we remain in a bear market that has significant unfinished business to the downside?

• Do earnings and the likely negative earnings revisions that are going to occur matter? 

• Or does the current negative sentiment, bearish positioning, technicals, falling inflation, and the hopes of a sooner rather than later dovish Fed pivot fully discount all the bad news that includes additional economic slowing and cuts to the forward profit outlook for Corporate America?

If you are in the camp that earnings and negative revisions cycles matter, my important metrics suggest that the evidence supports your concerns and ongoing bearishness.  And yes, I know the oversold squeeze rallies in the face of this are frustrating to say the least.  If you are in the opposing and more optimistic camp, I respectfully warn that sentiment, bearish positioning, and oversold conditions historically do not create sustainable longer duration bull markets by themselves based on my research, and my read of Chair Powell and Crew is the same as it has been – focused on fighting inflation and that they have the will to stay on the path until either their goal is achieved or something breaks.  Regardless of which view you currently have, consider yourself fully warned that my key indicators have had a strong track record since 1990 and that the possibility of the new bull market, having already started, would be rather unprecedented.  Importantly, additional support for my ongoing bearish view comes from this month’s deep dive review of the estimate revisions for the S&P 500 and a good portion of the remaining names in the S&P 1500 Super Composite, which shows two clear bigger picture takeaways – 1) the backdrop for forward estimate revisions continues to weaken at a gradual and consistent pace; and 2) that there is still a good bit of work to do before the pessimism for the forward outlook is OVERLY discounted,which is the historical tendency (i.e. based on my work, there is no doubt in my mind that forward numbers are still too high and will need to be lowered). 

Additional Key Assumptions: 

• Inflation has peaked
• The U.S. economy is decelerating, and fears of slowing have not reached their maximum level
• Forward expectations for corporate profits are too high and most certainly will need to be lowered, especially names that are more sensitive to cyclicality
• There has neither been a price nor fundamental capitulation yet, but they will both likely happen at some point in front of us
• THE equity market bottom, either a clear test of the June lows near 3600 or lower, has not been reached yet
• My work still suggests to sell rallies and not to buy dips.  

Bottom line:  The S&P 500 is likely beginning another tactical oversold bear market rally, but my research is still unfavorable and thus I am reiterating my somber view for the U.S. equity markets (And retain my in-house cranky bear position). 

For positioning, I am still recommending Growth, both defensive and offensive, relative to Cyclicality even though Tech has been weak over the last seven trading sessions.  The opportunity to aggressively pivot towards increasing risk, lowering cash levels, and moving to offense is still in front of us.  

SPECIFIC CLIENT QUESTIONS

• What were the main conclusions from your monthly single stock review from your ERM model that you did last week?  
• What areas stood out as relatively favorable/unfavorable based on your proprietary earnings revisions metric (ASM)?
• Did any single stock names really catch your attention?
• What are your most aggressive tactical indicators saying? 

MY ANSWERS

What were the main conclusions from your monthly single stock review from your ERM model that you did last week?

The earnings revisions backdrop continues to gradually get worse, and I would now call it U-G-L-Y times two. 

For me, this means that the number of stocks with negative sloped ASM indicators is broad based and still spreading.  Also, more names have fallen into the southern hemisphere with more and growing red bars.  It should be noted that the deterioration has remained quite modest as has been the case all year. 

Consequently, when just looking at the analyst community, there remains scant evidence of fear regarding economic slowing and that forward profits are too high.  I am a bit flummoxed that the pace of cutting has not yet accelerated.  With that being said, based on my macro work and the thirty year historical precedent of estimate revisions behavior, it seems nearly certain that the cutting cycle remains in the early phases, there is much more to come, and reaching fundamental capitulation will likely occur at some point in front of us, which will be a critical contrarian bullish signal that I am looking for to become more constructive. 

Why is fundamental capitulation important?  My research shows that since 1990 this has been a critical prerequisite for the equity market to put in a sustainable investment bottom (i.e., THE BOTTOM).   

I will reiterate once again that this process is likely to persist for at least another 1-4 months, at minimum.  Thus, patience will be needed if my analysis comes to fruition. 

What areas stood out as relatively favorable/unfavorable based on your proprietary earnings revisions metric (ASM) ?

Favorably standing out as relatively interesting based on earnings revision trends:

Lithium, Aerospace & Defense, Environmental & Facilities, Casino/Gaming related, Fast Food, AMZN, Distillers & Vintners, Beverages, Tobacco, HC Equip, HC Distributors, HMOs, Large Cap Biotech, signs of life in secular growth Tech/Software, Utilities. 

Unfavorable and look quite weak based on earnings revision trends:

Most cyclical names in Materials sector, machinery/cap goods within Industrials are at risk, Transports look awful, Retail/Discretionary Spending names within CD look terrible and more to come, Broad based weakness within Financials.

Did any single stock names really catch your attention?

Contrarian

FMC-1.03% , BA1.44% , GE1.30% , CZR-3.82% , SBUX-1.05% , AMZN0.96% , DHR-1.84% , RMD8.85% , ISRG-0.50% , HCA-1.54% , CLX-0.19% , FISV, ADBE-0.77% , ADSK0.65%

In-motion

ALB-0.25% , CMG6.33% , GPC-0.45% , ULTA, ABC, CAH0.26% , MCK0.84% , MOH-4.11% , COST-0.28% , KDP3.83% , LW-1.23% , PM-2.96% , SRE

What are your most aggressive tactical indicators saying?

As suggested in my comments on Monday, my most aggressive tactical tools were extreme and the start of another tactical countertrend bounce was likely to be imminent.  Well, they both flipped on 9/6 and the equity market has indeed stopped falling.  The S&P 500 will likely keep working its way higher until they roll back over again.  My expectation is that the duration of this upside move will last less than two weeks, but the rollover will be the ultimate signal.  Importantly, because my other key indicators are still unfavorable, I am viewing this bounce as another rally to sell into and NOT one to chase higher unless one is an aggressive tactical trader. 

My highest-frequency and most aggressive tactical tools for looking at the S&P 500 price action  — V-squared (orange line top chart) and HALO-2 (purple line bottom chart)  — both reached negative extremes and flipped to positive last week on 9/6, which are contrarian favorable signals.  Thus, it appears equities will make another attempt to bounce from an oversold reading.  Crucially, there has been zero change in other key metrics and my medium term unfavorable view.  So, the short-term focus now shifts again to trying to identify levels where this bear market rally might stall.  Based on the aggregation of my indicators, I would expect this bounce to be both short and smallish unless something else in my work began to support the move as more than a countertrend rally.