It has been an interesting week thus far.  The much-anticipated Valentine’s CPI release combined with the Retails sales data has caused a dramatic shift in expectations for the future path of Fed policy. The market’s expectations for the terminal rate have increased from 4.75% to almost 5.25%, which is in the low end of my longstanding 5.25%-6.0% range, nearly all the easings that were priced in during the first five weeks of 2023 have now been pushed out to 2024, and the total amount of expected Fed accommodation has fallen from 200bps to roughly 160ish.

My interactions with clients have been filled with a lot of confusion and frustration, and they are trying to better understand what may be occurring.  For the most part, if one is more open to technical analysis and charting, the recent price action seems justified to this group of folks.  However, if one is more fundamentally driven and trying to understand things using a data-driven logic of what the market is pricing in for Fed expectations, the economy, earnings, and valuation, a common comment is “I don’t quite understand why the market and certain areas are behaving the way they have been”.  For the record, I have been in and remain in this group as my key indicators are not supporting the ongoing bounce and have been flashing elevated risk levels that are rising.  Yes, the occasional data-driven person tells me, “Brian, you just don’t get it.  The inflation is going to keep falling to 2%, interest rates are going to fall, earnings are not collapsing, and this is bullish.”  

From my perspective, the risk-reward ratio for equity investors with the S&P 500 is heavily skewed towards risk.  My research suggests upside potential from here is possibly 4250, but downside risk is to at least 3800, likely lower.  So, I am still advising caution. 

Well, with all that going on, I spent most of last week doing my monthly deep dive at the single stock level using my ERM model that has a large earnings revisions component.  I look individually at roughly 4000 U.S. stocks during the week to get a deep-in-the-weeds view at what is happening with forward profit expectations.  When the macro picture is challenging and unclear, I always feel that diving deeper has helped me regain some clarity, and this month’s review provided some great insights for me. 

Switching gears to the February U.S. universe single stock revisions deep dive, the following observations stood out the most: 

  • Since March 2022, my reviews have shown a weak earnings revisions backdrop, and February continued the negative trend.  Thus, the slow bleed continues, but it appears that fundamental capitulation still has not occurred. 
  • Yes, it’s true that actual earnings announced during the current earnings season and forward profit expectations are not collapsing.   This has never been part of my forecast and isn’t a surprise to me.  With that being said, some are pointing to this as bullish, but my work still suggests that despite the domestic economy remaining resilient, forward expectations still need downward adjustments and will still be a headwind for upside gains for the overall S&P 500. 
  • As investors and bullish forecasters start shifting to the “No Landing/Goldilocks” scenario, my view is that the growth scare fears, and a shallow recession are still coming.  Granted, it looks like the timing has been pushed out. 
  • Favorably standing out as relatively interesting based on earnings revision trends:

Generally, growthier areas and names look close to bottoming or flashing early signs of less bad, which is contrarian favorable. 

Health Care — Equipment, Pharma, and Life Sciences — DXCM, EXAS, EW, HOLX, IDXX, ISRG, MDT, SYK, TFX, ZBH, ALGN, COO, ABBV, CTLT, ZTS, MNRA, LLY, MTD, PKI, and TMO. 

  • Note that Large Cap Biotech and HMOs are still showing signs of weakening. 

Staples— COST, MNST, CPB, KO, CLX, and PM.

Other large cap names that caught my attention — Casinos and related (CZR, LVS, MGM, and WYNN), BA, RTX, GNRC, GE, PH, CPRT, BWA, YUM, AZO, and NFLX.

And for you contrarians, I continue to strongly recommend revisiting INTC.  It may not be ready now, but once its dividend gets cut (my guess) and the stock falls, the stock screens as one of the most interesting contrarian stocks in the entire universe. 

  • Unfavorable and look quite weak based on earnings revision trends:

Too many to mention, but Cyclicals, which have been more resilient than I was expecting, are slowly cracking.  Growthier areas and names look close to bottoming or in early signs of recovery. 

The below are my updated macro/market thoughts:

  • NO EASING — Fed keeps the ultimate terminal rate unchanged for an extended period, …
  • Even though it appears less imminent, the economy looks headed toward a shallow recession.
  • Corporate profit expectations remain too high and need to be lowered as there are strong headwinds. 
  • Importantly, the immediate upside potential for the S&P 500 appears limited, at best.
  • Considerable risk remains for equity investors. 
  • Cyclicals are holding up, but my work says this is where the risk is growing the most.
  • Single-stock opportunities are sparse, but they are expected to increase.

Bottom line:  The dovish Fed expectations that grew during the first five weeks of the year and helped fuel the surge higher in equities, especially the most shorted names, have very quickly been pushed out over the past week while rates and the dollar are up.  The terminal rate is now in the bottom end of my long-standing 5.25%-6.0% range. Importantly, however, the index price level of the S&P 500 has yet to adjust to this dramatic shift.  Not only is this perplexing in my view, but it is also suggesting to me that risk remains elevated and immediate equity upside is limited, at best.    

Additionally, with the HALO indicator for the S&P 500 having had a negative inflection (see discussion later in this note), the likelihood of a tactical consolidation/pullback, at minimum, has considerably risen.  

Based on this and my updated macro thoughts, I am still advising being careful, cautious, and patient while being on full alert for potential opportunities that may present themselves during my expected challenging period. 

For relative investors, my work still sees attractiveness in classic Defensive non-cyclicals and some Offensive Growth areas.  I continue to be interested in the highfliers of the last cycle as some are still quite beaten up despite their respective 2023 bounces. 

GENERAL CLIENT QUESTIONS/CONCERNS/TOPICS

  • Continued confusion and frustration are still the most shared view by clients.
  • As I have commented for the past several weeks, most of my interactions have shared that they have been using the ongoing equity market bounce to trim unwanted legacy positions with limited buying in favorite longer-term names. 
  • The most common answer provided by anyone who is more constructive is always about technicals.  Very few, if any, are making a bullish case based on fundamentals or their views on the macro. 
  • Tech continues to be the most asked-about sector, and Energy is second. 
  • What is my ASM indicator showing for the broad-based estimate revisions trend? 

SPECIFIC CLIENT QUESTIONS

  • Have the earnings revisions begun to get less bad yet?  What does your S&P 500 ASM show?
  • Is your main HALO indicator for the overall market supporting this move still or is it flashing risk?
  • Have the earnings revisions begun to get less bad yet?  What does your S&P 500 ASM indicator show?

NO.  It has been going sideways, which is historically unusual.  The normal behavior at this point would be a sharp move lower as analysts’ fears about a growth slowdown rise and they aggressively lower their forward profit expectations.  Is this bullish?  In my view, NO.  It is taking some negative pressure off of equities, but there is zero evidence of a strong reversal and rise that is in the early stages.  This will be important to keep monitoring throughout 1H23. 

Equity Risks Remain Elevated
Source: Fundstrat Global Advisors
  • Is your main HALO indicator for the overall market supporting this move still or is it flashing risk?

NO, it is not supporting the equity bounce any longer.  It has ROLLED OVER.  In my recent sector upgrade note, I commented that the recent HALO reading is still drifting upwards, but with HALO-2 showing clear signs of weakening, the odds that HALO itself would roll over were rising, which suggests that the S&P 500’s tactical upside potential is limited, at best, and more likely to finally face some selling pressure.  Well, my key tactical indicator for the overall index has indeed had a negative inflection this week.   As you can see in the chart below, the last seven rollovers led to negative price action over several weeks, at minimum.  Thus, it appears that the S&P 500 will likely struggle for gains during for at least until early March, and possibly longer.

Equity Risks Remain Elevated
Source: Fundstrat Global Advisors and Bloomberg

By the way, we’d like your feedback. What parts of Brian’s research do you enjoy and value the most? Is there anything you would like to see that isn’t currently provided? We read everything our members send and make every effort to write back. Please email thoughts and suggestions to inquiry@fsinsight.com

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