All Eyes on Powell as Markets Struggle Amidst August CPI Report Array ( [cookie] => 94b382-14a86c-eb213c-ecdc36-16edd3 [current_usage] => 2 [max_usage] => 2 [current_usage_crypto] => 1 [max_usage_crypto] => 2 [lock] => [message] => [error] => [active_member] => 0 [subscriber] => 0 [role] => [visitor_id] => 164938 [user_id] => [reason] => Usage under limits [method] => ) 1 and can accesss 1
Our Views
STRATEGY: 2H rally view intact
Given the recent market carnage, 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
- On 9/13, the Nasdaq went 100% no bid – meaning there were zero advancers – for the first time since March 12, 2020. These “zero-ish” readings have not really happened at the start of a sell-off
- Since 1996 there have been 13 such prior instances where Nasdaq 100 went completely “no bid” – the forward returns for the Nasdaq post-zero bid are impressive, with the 13 instances having a median 12M gain of 21%
- These data support a structural bottom in Nasdaq. That is, when zero stocks advance, that is essentially one form of capitulation.
Despite strong Aug CPI challenging the inflation “past peak” thesis, we still view June 10, 2022 as the date of the fundamental capitulation
- We think there is an over-reaction to the CPI report, as what appear to be inflationary pressures in labor contrast with recent soft business surveys around labor and pricing
- 12 of last 14 inflation reports showed falling inflation, not “sticky”
- Over the past 2 weeks, there have been 14 major economic reports that are a snapshot on inflation (or an aspect)
- 12/14 show marked/sharp declines in inflation, including hard reports like PPI, import prices, and key surveys like ISM and regional ISMs
- Only CPI and perhaps JOLTS show any sticky inflation
- What does this tell us? While CPI is certainly key, the upside inflation surprise (negative) is not necessarily corroborated by the other inflation data, possibly due to lags/smoothing in CPI report
- 47% of 175 CPI components have outright declined from their 18-month highs, the highest figure in 2022 and up from 38% low in 2022
- 6 of 9 regions, representing 73% of GDP, of the US saw outright “deflation” in August, expanding from 5 of 9 regions in the July CPI
- regionally, the upside print on CPI were the Northeast (middle atlantic + new england) where apparel (back to school season) and residential electricity costs (natural gas) were the upside surprise.
Bottom line. We see 2H rally thesis intact.
- Seasonal trends in the back half of September should weigh on risk assets for the remainder of the month
- Cycles turn up in early October which should create a dip-buying opportunity for investors
- For the time-being, “Cash is King” as markets potentially test the lows seen in June before heading higher next month – Yields and US Dollar should push to new highs while stocks weaken
- Reiterating unfavorable view on U.S. equities and still targeting 3600-3500 as next downside area. Be defensive, protect, and remain patient for a better buying opportunity that is still in front of us.
- Forward profit expectations are still too high and more negative earnings revisions are still to come.
- Earnings matter, especially with the Fed clearly communicating their inflation fighting resolve.
- Despite some potential short-term relative risk, my work prefers Growth over Cyclicality, which has considerable downside to their forward outlooks.
- My Reddit-based sentiment indicator turned neutral (not negative) this week despite the overwhelmingly negative CPI release and market sell-off on Tuesday
- Price action has been driven by macro which is negative for stock picking
- Ethereum has merged successfully
- Economic data this week including Tuesday’s hot CPI number continues to impact crypto markets negatively
- A cut off of supply from miners has created a low-volume environment for Ethereum – we expect consolidation for the next few weeks
- The FOMC will meet on September 20/21, with the regular post-meeting press conference occurring Wednesday afternoon. Powell has been telegraphing policy and all indications point to a 75 bps increase for the September meeting. I expect Powell to reiterate that the Fed will not back down until the goal of 2% is reached, in line with his remarks at Jackson Hole and the Cato Institute.
- The October 1 deadline for Congress to pass a Continuing Resolution (CR) in order to avoid a government shutdown is fast approaching. Perhaps the largest challenge to averting this “made in DC” crisis involves the commitment made by leadership to Senator Joe Manchin regarding his proposal to speed up the regulatory process for high-priority energy projects. Many Democrats have iterated their intent to vote against any continuing resolution (CR) including the Manchin energy provision. Senator Schumer has stated his intent to include the energy provision in this legislation.
- Despite a strong historical precedent where the party in the White House loses seats in midterm elections, Democrats have made promising progress, with a slight bump in Biden’s approval ratings (likely helped further by his assistance in averting a national railroad strike this week). 10 races are likely to determine control of the senate: OH, PA, NC, NH, GA, NV, CO, and AZ. In the coming weeks we will observe closely.
Wall Street Debrief — Weekly Roundup
Key Takeaways
- The S&P 500 closed at 3,873.33 the Vix closed at 26.3.
- Markets fell over 5% on the back of a hotter-than-expected CPI (+0.1 MoM vs -0.1 expected).
- US Producer Prices fell .1% in August marking the second month in a row this figure has declined.
- Mortgage rates topped 6% this week for the first time since the GFC.
Good Evening,
Markets had a treacherous week following the hotter-than-expected August CPI print, with major indexes posting their worst weekly performances in months. Following Tuesday’s CPI release, the Nasdaq 100 went completely “no-bid”, all 30 stocks in the DJIA declined, as did all 11 sectors in the S&P 500. Yields propelled higher with the 2Y yield rising to 3.86% and the 10Y closing the week at 3.45%. All eyes remain focused on next week’s FOMC meeting, where it is expected that the central bank will raise rates another 75bps. The Bank of England and Bank of Japan are due to announce their monetary policy decisions next week as well, opening up the potential for increased volatility. Shares of FedEx tumbled after the shipping giant warned of a slowdown in deliveries, due to macro headwinds.
Friday brought some good news, with the University of Michigan inflation expectations survey showing expectations for future inflation declining. Median long-term (5-10 year) inflation expectations came in at 2.8%, down from the 2.9-3.1% range for the first time since July 2021. Expectations for 1 year inflation dropped to 4.6% from 4.8% a month prior. The latest UMich data may ameliorate concerns that high inflation expectations would become entrenched as they did in the 1970s. In his remarks at the Cato Institute’s Monetary Conference last week, Powell reiterated his stance that the Fed must act swiftly and decisively to bring down inflation in order to prevent expectations from becoming ingrained as they did in the Volcker era. Powell recalled that the public’s expectations of high inflation remaining the norm contributed to the difficulties in tampering inflation.
It may be helpful here to recall that Volcker’s anti-inflation program started when UMIch consumer inflation was at an all time high (10% for 1Y, and 9% 5-10Y). Volcker abandoned harsh measures in October 1982 when consumer inflation figures plummeted to 3% for the 1Y and 5% for the 5-10Y.
While the University of Michigan’s 1 Year inflation expectation came in at 4.6%, the inflation swaps market is showing a 3.4% change in the next year. Inflation continues to be one of the main focuses of investors.
In his most recent report, Tom Lee pointed out that if June 2022’s CPI print of over 9% YoY was, in fact, the peak of inflation, then equities should be able to hold the June low.
In light of this mixed bag of news, it may be helpful to consider how news is getting priced into the market these days. This week in our research huddle, our head of Portfolio Strategy, Brian Rauscher, made the point that with regards to economic data, good news = bad for markets and bad news = bad for markets. Naturally, bad economic data bodes poorly, and good economic data could encourage the Fed to be more hawkish. If that’s the case, you may be wondering: is there any such thing as good news for the markets these days? We think the answer is yes, in the form of leading indicators, which are displaying disinflationary tendencies. Our head of research, Tom Lee, sees the market sell-off after the CPI news as an over-reaction, juxtaposing the “wage-pressure driven CPI rising” with soft business surveys of late (UMich, NFIB, ISM). Mark Newton added that in times of immense selling pressure, stocks can follow cycles over fundamental news, adding that a notorious “bear-killer” month is ahead of us, and his cycles turn up in early October after a few weeks of weakening, which should create a dip-buying opportunity for investors.
August CPI was released this week and numbers exceeded consensus expectations, with actual YoY CPI elevating to 8.3%, 20 bps higher than the 8.1% expected. On a MoM basis, prices were up 0.1%, again outpacing the -0.1% survey-expected figure. As shown below, the implied Federal Funds Rate has been pushed up as market participants expect even tighter economic conditions amidst the recent hot CPI release.
The CPI release had several implications for the broader market as major indices tumbled in the biggest selling spree since June, 2020. The Dow fell -3.94%, the S&P 500 tumbled -4.32%, and the NASDAQ did a 180 degree nosedive, finishing Tuesday down -5.16%.
While the headline CPI number was indeed higher than expected, our very own Tom Lee points out that 6 out of 9 regions are actually seeing deflation MoM, which bodes well for the future outlook of price pressures. He notes that “6 of 9 regions saw outright declines in CPI representing 73% of US GDP.” In July, this was 5 of 9 regions, representing 49% of GDP.”
Another headwind for markets was narrowly avoided Thursday morning, when the White House announced a tentative deal had been reached and the looming railroad strike would not proceed. As Tom Block, our Head of US Policy, stated, the economic consequences of a rail strike would have been disastrous. According to the U.S. Department of Transportation, rail accounts for 28% of ton-miles of freight transported in the U.S.
There was no discernible market reaction to the tentative deal as the market was preoccupied with CPI headlines. However, the potential to avoid a prolonged strike is a supply chain disaster avoided.
Next week’s FOMC remains the key event to watch. We hope you have an excellent weekend!
Best,
FS Insight Team
Important Events
MoM: 0.1% YoY: 8.3%
Core MoM: 0.3% Core YoY: 6.3%
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.
Expected: +75 bps Implied Probability from Futures: ~80%
The Fed will be meeting Tuesday and Wednesday of this upcoming week.
Survey: 217k Prior: 213k
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.
FS Insight Media
Stock List Performance
| Strategy | YTD | YTD vs S&P 500 | Inception vs S&P 500 | |
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Sector Allocation
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+11.75%
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+15.38%
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+33.22%
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Small Cap Stock List Performance
| Strategy | YTD | YTD vs Russell 2500 | Inception vs Russell 2500 | |
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SMID Granny Shots
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-0.88%
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+6.59%
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+25.31%
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