Market Has First Week Up After Three Down, Dollar Reversal Spurs Risk Rally In Equities
Our Views
STRATEGY: 2H rally view intact
Given the list of legitimate risks for equities, the natural question is how is there a positive thesis on equities into 2H2022? Here is our take:
- Our continuing analysis shows leading indicators point to disinflationary/deflation
- US corporates remain impressively resilient, enduring the pandemic global shutdown with cost discipline
- And US corporates are weathering the inflation surge impressively as well
- The US economy has managed to absorb rapid Fed rate hikes so far
- And US economic relative positioning far stronger in 2022
- US net beneficiary of higher energy prices, absolute and relative (US exports oil)
- US is on-shoring assets = future competitive advantage
- US has labor issues, but this will be solved by either automation or rise in workforce participation
- Investor sentiment is rock bottom and worse than GFC by some metrics
Even with bad September seasonals, a roadmap exists for positive catalysts into month-end
The August CPI released on 9/13 is particularly important for markets. And it looks like the inflation-swaps and bond markets are expecting outright deflation. We have highlighted this multiple times.
- Deflation month-over-month of -0.2% (August)
- 12m inflation forwards are now 1.7% down from 6% in June 2022
- Wow, inflation expectations are tanking
- At a time when Fed officials are still talking tough on inflation
- We think this remains a setup where downside reads in inflation means Fed has less work to do
- Fixed income markets show far less inflation in swaps, etc
- And while many believe “bonds are getting it wrong” including Fed officials
- The drop in energy and housing and other indicators are supportive of this lower inflation outlook
- Hence, Fed could do far less tightening as the market is doing Fed’s work
Bottom line. We see 2H rally thesis intact.
- SPX bounce should be able to extend into next week ahead of back-month weakness (4125-50 initially important)
- Financials and Healthcare outperformance have served to buoy SPX despite Technology lagging
- Crude oil is nearing downside technical support targets, and expected to stabilize at $79-81 and turn higher
- If earnings matter, then my work suggests that equity markets still have considerable downside risk remaining.
- It is highly unusual for a sustainable price bottom for the S&P 500 to occur before capitulatory analyst forward profit downgrades.
- The domestic economy has many challenges and is not likely to meaningfully reaccelerate any time soon, which creates major headwinds for earnings.
- I would likely start to become less bearish on equities if there was finally capitulatory selling pressure combined with a VIX spike to over 40, which would be contrarian favorable events.
- My Reddit-based retail indicator turned negative which is a contrarian bullish signal, implying markets could rally in the immediate future.
- The recent rally was not supported by fundamental factors, and my work still suggests equities are relatively overvalued.
- Companies start talking about 2023 full-year earnings next quarter, which could be a negative catalyst for markets.
- Despite being less than a week away, we think the Ethereum Merge is still an undercrowded trade. For those wishing to review a comprehensive summary on the matter please see our deep dive on the network upgrade.
- An increase in transactions coupled with a recent network upgrade makes the Arbitrum ecosystem as an intriguing opportunity for investors.
- Strategy – We continue to be long BTC, ETH, and SOL into year-end and think that Merge-adjacent names, including LDO, RPL, OP, and MATIC, still present attractive opportunities for high-beta exposure into the Merge. Investors should look to use any dips as buying opportunities.
- Powell spoke at CATO Institute: He believes that today’s inflationary mentality is not the problem; but gone unchecked it will become part of economic decision-making and expectations could become unanchored.
- Breaking inflation before this happens is at the core of the Fed’s thinking. Powell is convinced that being tough now should avoid the high social impact of the Volker policy.
- When the House returns to DC next week they will have less than three weeks to pass legislation to fund the government before the new fiscal year begins October 1. Failure to pass will result in a partial government shutdown.
Wall Street Debrief — Weekly Roundup
Key Takeaways
- The S&P 500 closed at 4,067.36. The VIX closed at $22.79.
- Markets shook off continued hawkish rhetoric from the Fed and risk assets rallied as the US dollar and rates receded.
- High P/E stocks and crypto assets rallied strongly. The Nasdaq performed best. The Russell 2000 also outperformed the Dow and S&P 500.
Good Evening,
Stocks ended up this week up after three straight weeks down. Shortly after opening, the S&P 500 moved above its 100-day moving average. It was a risk-on rally led by Communication Services, Energy, Technology, and Consumer Discretionary respectively. The Nasdaq outperformed and Bitcoin also took off, climbing about 10%. The Russell 2000 also outperformed this week. The dollar retreated from recent highs and the 10-yr retreated earlier in the day and then went back up into the close. Stocks ended up closing near their highs of the day. There is a Fed meeting on September 20-21 and it now appears that a 75-bps hike is likely based on Fed Futures. Next week's CPI reading will likely be a consequential data point so probabilities may change between now and then. Economists have begun to revise inflation forecasts downward.
Data from EPFR Global showed nearly $11 billion in equity outflows in the week to September 7th. Technology led the outflows accounting for about 16% of the selling. Sentiment has reached extremely bearish levels. The selling has been significant since Jackson Hole, but it has also been relatively orderly compared to prior run-ins with a hawkish Fed this year. Markets rallied despite the continued expectations for hawkish Fed actions. Powell himself and a chorus of other Fed speakers continued the hawkish bent in their rhetoric this week, and breaking inflation's back is their raison d'etre right now. Still, it is worth pointing out that in mid-to late-2021 the bond market was pointing to severe inflation ahead when the Fed was saying it would be manageable and transitory. Now, we are in the opposite situation. The Fed is saying inflation must be battled at all costs, and the bond market is sending signals that suggest it's not as worried about inflation as the Fed this time.
There are no doubts that financial conditions are tightening, though. US household net worth for the second quarter went down by the largest amount on record, by a stunning $6.1 trillion. Consumer credit excluding mortgages grew at the highest annual rate since 2001. The credit cycle seems to be lagging a bit as Federal stimulus likely interrupted normal demand patterns. Defaults in the leveraged loan market reached their highest level since August 2020. The European Central Bank also did a 75-bps hike earlier this week, which helped financials get in on the recent bounce as well. Rates have gone up across the US Treasuries curve since Jackson Hole and housing affordability is at an all-time low. However, our team even sees evidence that shelter might roll over sooner than consensus expects, as Tom Lee discussed in his most recent First Word.
Quantitative tightening (QT) is doubling its pace this month on September 15th, which some fear could be a problematic catalyst. The Fed owns roughly a third of the market for Treasuries and Mortgage-Backed Securities. Our team will be keeping an eye on how this plays out and reporting to you. However, consider that many folks appear to be pretty well hedged for this eventuality. The Fed also won’t want to draw too much liquidity out of the banking system as they still have to consider their mandate to safeguard financial stability.
The Fed Beige Book was released last week, and it showed growth had slowed in 9 of the 12 districts. There was also a flurry of Fed commentary before the communications blackout starts next week. Fed Chair Powell’s comments were well covered, and he reiterated his commitment to anchoring inflation expectations. Lael Brainerd, typically more dovish, said that there are also serious risks to raising rates too high. San Francisco President Mary Daly said the Fed does not have to do “outrageously large things” to tame inflation.
New York City now has 101.8% of its pre-pandemic office employment. TSA data also shows that 8.76 million travelers went through airport checkpoints on Labor Day weekend. This was slightly higher than the figures from Labor Day weekend in 2019. The strength of demand in the travel industry and commentary from travel company earnings show a durable consumer who might be somewhat down but certainly not out. American Express was one of the best-performing Dow components this week.
Large-cap Technology shone today. Apple, Amazon, and Microsoft all had a great day. Brian Rauscher’s research is pointing to relative strength in growth versus cyclicals, both defensive and offensive. The rest of our research team is pretty constructive on Technology, but notes there could be some bumpiness ahead. Most of the FAANG reside on our Granny Shots list. Adam Gould’s retail sentiment turned negative again, suggesting a short-term bounce is possible. Mr. Gould still sees the market as overvalued, though. Mark Newton thinks we can sustain this bounce into early next week and get to the 4,125-4,150 range. He thinks we’re entering a period of elevated volatility and this bounce could reverse course next week.
Overall, the Bears are waiting for the shoe to drop on earnings and a surplus of macro risks. The Bulls are encouraged by earnings and the resilience of the consumer. Extremely negative sentiment helps their case as well. Evidence that inflation has peaked is mounting, and as Tom Lee said during our research huddle yesterday if inflation comes down faster than anyone thinks it is possible that the Fed even surprises itself. The CPI print next week will be a key short-term catalyst to keep an eye on. We hope you all have a wonderful weekend. We’d like to offer our thoughts and prayers to the family of Queen Elizabeth II, the new King Charles III, and to all our friends in the United Kingdom. God Save the King!
Cheers,
FSInsight Team
Important Events
Est: 8.1% Prev: 8.5%
The CPI is release by the Bureau Of Labor Statistics. It measures the change over time of a basket of goods and services. Data can be broken down geographically. Prices data for key components like energy and food are reported as well.
Est: 227k Prev: 222k
The initial jobless claims are reported by the Department of Commerce and measures how many applications for unemployment insurance have been received over the past week.
Est: 59.5 Prev: 58.2
The University of Michigan Consumer Sentiment is on a normalized scale of 1 to 100 and is based on interviews with consumers revolving around 50 core questions. This print also includes consumer inflation expectations going forward.
FS Insight Media
Stock List Performance
| Strategy | YTD | YTD vs S&P 500 | Inception vs S&P 500 | |
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Granny Shots
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-9.90%
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+4.68%
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+73.00%
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View
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Sector Allocation
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-15.70%
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-0.73%
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+1.20%
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View
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Factor Strategy
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-12.78%
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+1.61%
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+0.63%
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View
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Brian’s Dunks
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Performance available here.
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