rally

• Your Weekly Roadmap

Jun 12, 2020

Nothing like a nice 5% selloff to get your attention, eh? Gets the juices flowing, makes you think. Or is it worry? Just when you thought the bear had raised the white flag and slunk back into his dark cave, there he was again bearing sharp teeth and slashing at investors last Thursday. Yes, the stock market fell sharply last week, about 5% by Friday’s end, and the drop was even deeper at its nadir, down almost 7% from a high of 3233 Monday. Oh, for the happier days of just—well a few days ago. I, and my colleagues Tom Lee, Brian Rauscher and Rob Sluymer as you’ll see in following pages—don’t view this as the beginning of the end of the rally since March 23. We look at the data, whether the coronavirus (COVID-19) stats, or corporate earnings estimate revisions, or technical analysis, and it doesn’t look like a bear market rally. It looks like a bonafide rally. A few factors seemed to have depressed the formerly more enthusiastic investor sentiments. First, the fear of coronavirus (COVID-19) returning is ever present and just below the market’s surface. The rally’s been big but sentiment remains fragile. There were some media headlines about some states experience increasing cases. However, as Tom Lee points out, beginning page 3, the headlines and the facts aren’t the same. There is no strong evidence so far of a serious “second wave” as states reopen. And secondly the Fed’s FOMC meeting finished Wednesday and its outlook was less than thrilling. The idea that the Fed will keep rates low through 2022 might seem good for stocks, but the corollary to that is, “Wait a minute, the Fed thinks the economy will need rates to stay low that low.” Cue the despair and the bear roar. For more on this, see page 12. Last week, the Standard & Poor’s 500 index finished around 3041, giving back the gains of the previous week. The market is up 4% from 12 months ago. Then of course the market had gone a long way in a few weeks; it was ripe for any excuse in my opinion. Last Thursday, the S&P 500 saw its largest single-day downside shift in the percentage of overbought stocks since at least 1990, according to Bespoke Investment Group. On Monday, the net percentage of overbought stocks (overbought minus oversold) reached as high as 89%, but that fell to 6% after Thursday’s rout. But BIG also notes that one, three, and six months later, the S&P 500 traded higher all four times. In the one-year time window, the median gain was 16% with positive returns three out of four times, ranging from a decline of 1.36% after the 2007 occurrence to a gain of 21.5% after the 1997 occurrence. I find that comforting. While we’re on the subject of technical things, you can get your fill from Rob Sluymer on the website today, where there’s a special look at some hard-hit cyclical stocks. Moreover, I will note that the market saw 90% up volume days on the previous Friday and last Monday, similar to the first rally days in March. That’s strong stuff. As Wellington Shields put it in a recent report, you just can’t expect that kind of momentum to persist three months in. The numbers are long term bullish, even if short term the market is stretched and a little frothy. This is the kind of pullback we’ve been saying to buy, if you missed the initial 40% from March 23. As Tom Lee has pointed out again and again, there remains a lot of dry powder sitting on the sidelines in the form of cash. There’s simply too much of it for this to be the sustainable return of the bear. The reopening of the US economy isn’t going to be smooth but it is going to happen. Moreover, even if there is a second wave, I doubt there will be a second shutdown, but a more balance approach of masks, hand washing and distancing. On Thursday, Labor Department data showed 1.5 million Americans applied for unemployment benefits in the week through June 6, extending a drop from a recent peak of nearly 7 million applicants in the week through March 28. The Cboe Volatility Index, or VIX (dubbed the market’s “fear gauge”) jumped to about 40 from 25 during the week with Thursday its biggest one-day increase in more than two years. Quote of the Week: From WSJ: The net worth of U.S. households saw a record decline in the first three months of this year as the coronavirus pandemic sent shock waves through the economy and caused equity prices to plummet. Household net worth fell 5.6% in the first quarter from the previous three months to a seasonally adjusted $110.79 trillion, the Federal Reserve said Thursday. That was the largest single-quarter drop in records going back to the early 1950s. Gross domestic product contracted at an annualized rate of 5% in the January-to-March period. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to

• Alpha City

Jun 12, 2020

Given last week’s pullback, I remind investors to keep your eyes on the bigger target, the horizon six, 12, and 18 months away. Our work tells us that equity markets will be higher in the future. Additionally, from a positioning standpoint our proprietary sector single stock quantitative stock models still strongly suggest that offensive, like tech and cyclicals, areas will lead at the expense of cash and traditional defense sectors. I continue to recommend a barbell approach of Growth/FAANG and Value/Cyclicals. The bears claim the rally since March 23 is non-sensical, a bubble, disconnected from the economy, and only rising because of Fed policy. The impressive equity market bounce that began after our preferred tactical indicators flashed a buy signal on 3/20 has not only made sense, but also has the underpinnings for more gains. Our research is supported by the following: Extreme oversold condition that occurred on 3/20 and positive inflections in all our preferred tactical indicators; earnings revisions that have clearly turned less bad; investors valuing the S&P 500 and its constituents on some type of forward normalized earnings, NOT trough profits; and valuation expansion that is based on historical factor analysis of what drives multiples. Additionally, unprecedented monetary and fiscal policy has rained on the economy, with more likely. Finally, continued skepticism by investors, which is a contrarian positive, and helps equites climb the proverbial Wall of Worry. Earnings revisions are clearly getting less bad. This is VERY important. This alone strongly backs the rally and makes a case against the market being illogical or only being fueled by Fed Policy. The historical precedent for this is powerful with no exceptions for major market bottoms since 1990. Markets don’t wait for profit growth to return to absolute positive before beginning to rally. The key driver has always been positive inflections and signs of less bad. The number of companies with absolute revisions positive and improving has risen once again. I generally expect all these figures to continue to trend higher for the next 4-8 weeks. I will be on the lookout in coming months for more names are shifting from “earnings revisions still absolute negative but less bad” to “absolute revisions positive and improving,” or double plus. Our research suggests that valuing the equity market or specific stocks on the current depressed profits levels from the self-inflicted corona virus lockdowns is misleading and not reflecting the true earnings power of Corporate America. Normalized earnings stream provides a better gauge. Investors should use at least 2021 and or 2022 EPS estimates, preliminarily a range of $180-200. I take exception to comparing forward P/Es absolutely with historic readings. Without considering other factors, including interest rates, inflation one is really comparing apples and oranges. At the 2000 S&P 500 price and valuation peak, the fed funds rate was above 5.5% while today’s level is near zero. In our view, this alone clearly argues for a higher level of valuation for equities. I could make a case based on historical valuation analysis that P/Es should not only be at the north end of their long-term ranges but should also trade at all-time peak levels. If the current low level of interest rates stays in place and inflation remains quiescent, the forward P/E could reach 20-22x the normalized OEPS level for 2022, which may prove to be conservative. Thus, we see a range of 3600 (20 x $180) to 4400 (22 x $200) as achievable over time.