2022 Is a “Pie In The Face” Kind of Year, Thoughts on Netflix

If someone asked me to describe 2022 so far, it is a “pie in the face” year. The world is facing several key turning points (inflation, supply chains, monetary policy, war) and these combined effects are impacting equities, bonds and commodities in a way not seen in the past 30 years. While our base case for 1H2022 was “treacherous,” the realized treachery is far greater.

• but as painful as equities have been since the start of 2022
• our base case is that 2/24/2022 is the “low” for 1H2022
• and while stocks won’t go straight up, we think risk/reward still remains attractive 6M to 12M out

Capital gains taxes owed on 4/18/2022 estimated largest in history >$800 billion (for tax year 2021)

Equities have fallen in a straight line since late March (13 trading sessions) and the decline continued into April 18th. We have written about the impact from IRS taxpayer deadlines for this effect:

• we highlighted stocks tend to do worse into tax day when prior year (tax year) gains strong
• this is due to cash raised to pay for taxes

• we highlighted that we estimate 2021 capital gains taxes owed likely >$800 billion, a record
• and another $150 billion or more for crypto capital gains

This is our rough math for how we derived $800 billion in capital gains taxes owed.

Since 1945, post-tax day returns strongest when “big tax hit” involved = strengthens case for near-term upside

Our data science team, led by tireless Ken, compiled forward returns for equities post-tax day. And based on the tiers (deciles) of return, using the tax year gains — in this case, 2021 tax year gain was S&P 500 +29%.

• post-tax day gains are particularly strong when tax year gains are highest two deciles
• we looked at 3M forward return and top 3 deciles had highest win-ratio and 3M gain

• intuitively, this makes sense
• if investors need to raise cash to pay taxes, this drives indiscriminate selling to tax day (4/18/2022)
• thus, the bounce subsequent to this reflects the alleviation of this selling pressure

Data by Wayne Whaley also shows next week post-tax day returns expected to be strong

This tweet by CMT Steve Deppe @SDJ10304 also highlights a similar effect. He is citing statistics by Wayne Whaley (WW Market Commentary Studies). This shows that:

• for the week ending 4/18
• when equities down for that week (4/11 to 4/18)
• equities higher 14 of 17 times
• median gain is +1.75%

So you get the picture. Stocks should be bouncing hard this week.

Powell speaking at IMF Forum solidifies expectations for 50bp in May

Fed Chair Powell spoke Thursday at an IMF panel with Christine Lagarde (ECB President) and this is his last appearance before the FOMC policy meeting May 3-4. There will be some incoming data in the next 12-14 days including GDP print, April jobs report and ISM reports. Thus, the Fed will have some additional information between these IMF comments and the FOMC meeting.

• but as highlighted below
• Powell said he believes it is “appropriate” to move more quickly
• And this suggests Fed will likely pursue a 50bp hike in May

This is not necessarily a market surprise, but this is a reminder that the Fed needs to be pursuing “tight” policy as long as inflationary pressures seem to be rising and as long as bond markets worry about inflation.

…Inflationary pressures not necessarily due to demand, but Fed policy can only address demand Powell, in his IMF session, acknowledged that many inflationary pressures could be due to supply-chain issues, policy (war and also US) and that the Fed’s primary tool to deal with inflation is to use monetary policy to slow demand:

• in other words, the Fed wants to use monetary policy to tighten
• which in turn raises the associated costs of money and other services tied to rates
• which in turn, impact demand
• similarly, the cost of money can rise in anticipation of tighter policy

…Already, cost of money is up sharply in past 6 months… market doing Fed’s work

And this is evident by look at the cost of money in the US. Take a look below:

• auto finance rates are up 55bp, or raising cost of financing a car by +15%
• mortgage rates are up +210bp, or 66%, raising cost of borrowing 66%
• The mortgage market has already priced in 4 rate hikes

The Fed needs to be speaking sharply about inflation and managing inflation, as the cost of losing credibility is high. And at the same time, the bond market itself can price in the future path of rates, thus, delivering the tightening the Fed would like to see.

…Already, used car prices down 3 months in a row = reflecting easing inflationary pressures

Used car prices, using the Manheim Used Vehicle Index, are now down 3 months in a row (4 if we consider “flat” the new down). Used car prices soared in the past two years, principally due to the shortages of new vehicles as pandemic-driven supply chain shortages made existing cars more valuable:

• we highlighted earlier this week that new car sales are well below 2019 levels by about 2 million
• yet the auto prices have seen significant inflation

…Auto prices represented 193bp of the 397bp, or half of the increase in inflation in the past 12 months

The rollover in used car prices is a big deal. What many do not appreciate is that used and new cars represented about 193bp, or half of the rise in inflation in the past 12 months.

• thus, if used cars prices stay FLAT, CPI impact drops to 0% in 2H2022
• this is a 193bp reduction in inflation rate in 2H2022

• if used car prices fall 10% in 2H2022
• this would be a +193bp + a further 100bp reduction in inflation in 2H2022
• meaning, auto prices would subtract nearly -300bp from inflation in 2H2022

This would be a big deflation in inflation.

COVID-19 is retreating across all continents… if we squint, USA is curling up modestly

The regional trends in COVID-19 cases is down everywhere. This is a break in trend compared to March:

• in March, cases were rising in Europe and Asia
• But both regions case trends have turned down sharply
• and only USA might be seeing a modest uptick

More encouragingly, China cases rolling hard finally

More encouragingly, look at China. Cases are finally rolling over hard.

• So, after fighting BA.2 and Omicron, it looks like China is finally getting ahead of COVID
• Hong Kong has seen a collapse of COVID-19 in the past few weeks

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