Markets Continue To Show Resilience, Evidence of Potential Strong Forward Returns Is Ample

STRATEGY: Consensus bearish, yet markets resilient = market “whispering” bottom

While consensus remains bearish and pundits warn of dangers ahead, we still lean “bullish” against consensus
With each passing day, when 1H2022 is characterized as “treacherous,” it is increasingly obvious. Think about the threats to equities:

• Bond market is hawkishly confused (messed up yield curve) and bullying Fed
• Fed officials are going full blown hawk-mode (Kashkari yesterday)
• Oil surging
• War headlines depress with today’s threats of chemical and even nuclear attacks
• Yield curve flattening
• Economists say odds of recession nearly 100%

…Markets “whispering bottom” while investors shout “top”
So it is not surprising that equity investors have turned so flat out bearish.

• March BofA Fund Manager Survey showed institutional investor cash matching 2009 levels
• AAII Retail sentiment worst since April 2009
• Investors Intelligence sentiment worst since 2009
• Consumer Confidence shows sentiment worst since 2009
• S&P 500 had a waterfall decline falling 15% in less than 20 trading days
• Our @fundstrat twitter feed is filled with angry investors “yelling at us” (even though we warned 1H would be treacherous)

Yet, equities have been resilient. Yup, resilient.

• not “dead cat bounce” resilient
• stocks surged 4 consecutive days > 1%, a rare feat (@ryandetrick great stats)
• Fed’s Kashkari is full hawk suggesting 7 hikes and markets up

And interestingly, the resiliency of equities is only seen around market bottoms. In fact, take a look at the stats from @CalebFrazen on twitter. He notes that a 52-week version of the Williams %R became oversold.

• this is the 7th time since 2003 it is this oversold
• 4 of 6 times, it was a multi-year low for NASDAQ
• median 1-year return is 25%

• S&P 500 “plus days” have been gains of 1% or greater, 9 times in a row
• per @ryandetrick this only happened twice in last 15 years
• June 2009 and April 2020

REMINDER: Bond market has “over-estimated” Fed hikes in the past 15 years, consistently
Are investors over-estimating the amount of Fed hikes, and by implication, the inflation risks?

• if history is a guide
• yes
• we re-post this “squiggles” chart below, created by tireless Ken

This chart shows the implied Fed funds rate 24-months out:

• compared to the actual Fed funds rate
• since 2008, the bond market has consistently “over-estimated” the number of Fed hikes over the next 12-24 months
• In late 2019, for instance, Fed futures saw 3-4 hikes by end of 2020
• instead, Fed slashed rates

So will 2022 be any different? We are monitoring this closely. But as we have analyzed in past reports, much of the rise in CPI is “goods” categories, compared to services. And “goods” CPI, about half of the rise in inflation in the past 12 months, stems primarily from supply chain issues. If currency debasement becomes central, then we could see inflationary pressures rising. But the dollar has been relatively stable/strong.

STRATEGY: With NASDAQ already in a “bear market,” the risks of a recession are already substantially discounted
Even with the bond market signaling substantial economic risks, we don’t think this means we need to sell equities here. Our clients know that we have show multiple studies in the past few weeks showing that:

• “one cannot get hurt owning stocks over the next 12 months”
• meaning, we think a lot of bad news is priced in

• BofA Fund manager survey shows “recession”-level cash positions = contrarian buy signal
• Consumer confidence is already at 2009 levels = historically bullish equity signal
• VIX soared to nearly 40 = tactical buy signal
• Nasdaq is already in a “bear market” = bad news priced in

So, while our base has been that we see 1H2022 as treacherous, we also believe we are at the lower-end of this “treachery” range. Thus, while visibility will improve in 2H2022, we believe stocks have already discounted a lot of bad news.

…recent 4 consecutive day rally > 1% (each day) underscores “one cannot get hurt here”
Moreover, I love this statistic posted by Ryan Detrick @RyanDetrick on twitter last week:

• S&P 500 gained 1% for 4 consecutive days
• happened 5 times previously
• 5 of 5 times S&P 500 higher 6M and 12M later
• median gain 17%/ 28%, respectively

So, again confirming the view that one cannot get hurt owning equities here.

…Goldman Sachs chart underscores need to “own” equities + value if stagflation (incrementally)
Lastly, I found this chart by Goldman Sachs useful. This is by their macro team and looks at historical allocations under different market conditions:

• I highlighted “stagflation” or “financial bubble” periods
• equities outperform bonds handsomely in stagflation (or inflation)
• Value trounces Growth

These are not a surprise. But think of it this way:

• if one is worried about stagflation
• should one be selling stocks or bonds?
• history says own equities, not bonds

…FSInsight sees less than a 15% chance of a negative outcome, better than market assessment of 50%-ish
What do we see as odds of a negative outcome? The future is uncertain. But we see the odds of a recession far lower than consensus:

• as many point out, the yield curve is implying a 50% chance of a recession
• we see the risk at 15% or less, meaning recession should not be priced into the “central case”

To state the obvious, the key to market outcome, is whether events in coming months lead to

• positive outcome for economy –> inflation cools or War ends
• negative outcome for economy –> inflation becomes “unanchored” or war expands

The key pivot, arguably, is the direction of inflation. Why not war?

• Wars are generally economically stimulative
• that is why markets tend to bottom at invasion –> remember “sell the buildup, buy the invasion”
• that happened in 2022 already

Figure: Themes in 2022 – “BEEF”

Per FSInsight

Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500

** Performance is calculated since strategy introduction, 1/10/2019