The “big news” in December CPI is 59% of components are now in deflation. Ultimately, the December CPI report is a net positive, in our view, as we think investors will increasingly conclude the Fed can declare “mission accomplished” on inflation.

• December Core CPI (1/12 at 8:30am ET) came in “soft” at +0.30% core MoM%, the 3rd consecutive month of soft inflation readings. The 3M annualized (SAAR) Core CPI is down to 3% and as we noted in prior reports, is more important than YoY rate (5.7%) because of the slowness of YoY% to reflect changes.
• Disinflation (aka “deflation”) is accelerating. A whopping 59% of CPI components are now in outright deflation, a leap of 800bp in a single month (see below). The 50-year average is 50%, so the pace of items “deflating” is also well above the long-term average. We view this as repeatable low CPIs.
• Applying the same MoM% to Dec Core PCE (Fed preferred measures) implies Core PCE inflation likely comes in at 4.2%-4.3% YoY% when released on 1/27. This is 60bp lower than Fed’s Dec forecast for 2022 (aka SEP) at 4.8%. 60bp is whopping downside surprise vs Fed forecast
• The latest Atlanta Fed wage tracker was released and the YoY% fell to 5.5% in Dec, the lowest reading since Jan 2022. The YoY% dropped for both “job switchers” (7.7% vs 8.1% Nov) and “job stayers” (5.3% vs 5.5% Nov). Another data point corroborating that wage inflation has slowed sharply in the past few months.
• Wage gains and job growth visibly slowed, developments favorable to the Fed perspective which has been targeting slowing wage pressures. Recall last week, total income (payrolls * avg hourly earnings) are now growing at a mere 3.6% or so, in line with levels needed to sustain 2% inflation.
• The Fed narrative on inflation has focused on “core services ex-housing” as of particular concern, since this category (medical, entertainment, cell phones, education, auto repair) has a heavy wage component. For December, the inflation rate was 0.211% MoM%, the third consecutive soft reading. The 3M SAAR figure is down to 2.12%.

These economic reports arguably show the bond market got it right. Inflation is undershooting the Fed and consensus view. This explains why UST 2-yr yields (4.145%) and UST 10-yr (3.444%), are far below the 5% Fed terminal rate.

For an equity investor, what is evident is inflation is falling faster than expected. And the Fed’s motivation to push for a “hardish” landing is diminishing given the softening of the labor market. We believe conditions are becoming more conducive for the Fed to allow financial conditions (FCI) to ease, and in turn, the environment for equities will be sustainably firmer.

Thus, we expect stocks to act far more resiliently in 2023 than consensus expects.

This means there are more reasons for volatility to fall – the Fed has less pressure to re-accelerate hikes, bonds already sniffing a “pause” than for EPS estimates to tank – weaker USD supportive and softish landing possible if labor is slowing.

• As we noted in our 2023 Outlook and in subsequent pieces, the key to 2023 is more dependent on the former. That a drop in VIX will be more influential for stock returns than EPS (see analysis below). And the VIX averaged 25 in 2022, and we think it could fall below 20 for most of 2023.
• It already is happening. With yesterday’s CPI report, the VIX fell 9% to sub-19. Our past analysis shows that in the past, this implies stocks could gain >20% in 2023. And with the strength in first 5 days, this case seems stronger.

By the way, Technology has increasing sensitivity to easing FCIs, meaning if financial conditions ease, Technology should rally the hardest.

• SPX’s minor weakness really hasn’t done much damage. Upside resistance is 4120.
• I remain optimistic on Energy and on WTI Crude. I feel that lows very well could be in place for WTI Crude, and pullbacks after recent strength likely turn out to be excellent opportunities to buy dips.
• This new year has brought about a nice bump in small-caps which many feel should kick off a period of outperformance given their widely known discount to large-caps approaching the biggest in years. However, daily charts don’t support that small-caps have made enough progress to make this call.

• The U.S. equity market generally had a strong week on the back of additional inflation-related data that showed that the trend in moderation has continued, which has led to financial conditions easing quite a bit, as well as lowered expectations regarding the Fed and how much policy response is still remaining.
• In addition, the VIX has fallen nearly 15% since last Friday, also creating a tailwind for stocks. This certainly puts the hawkish/bearish forecasts under question.
• As we move forward, the news flow will begin to shift somewhat away from macro towards micro as the 4Q22 earnings season is now underway. There are some concerns from investors that the corporate-profit backdrop may be deteriorating. I am expecting the actual reports will not be a disaster and to be better than expected as is nearly always the case, but my main focus will be on the forward guidance that corporate managements will be providing for the coming quarters.
• Although it is challenging and frustrating to have the equity market go against one’s main thesis, my key indicators are not supporting the current bounce let alone significant upside potential from current price levels. Thus, I remain cautious and worried about downside risk.
• As I stated in my 2023 Year Ahead Outlook that I released this past week, there will be tactical opportunities for aggressive traders. Importantly, however, my work continues to flash that there is still unfinished business to the downside, and that strategic investors will need patience. The tug of war between Doves/Bulls vs Hawks/Bears is likely going to be playing out for at least a few more months based on my work.

• After a December in which they outperformed the SP 500 by as much as 3%, we see conditions in January continuing to favor value stocks.
• Similarly, conditions for growth stocks seem to be steady for this month; they underperformed, and we do not see that changing.
• Momentum continues to favor low volatility stocks, and we continue to recommend overweighting them this month.
• As earnings season gets underway, with the continuing growth in importance in stock picking, we think the large differences in how the market treated “beats” and “misses” in 2022 will persist into 2023.

• Cryptoassets performed well following the soft CPI print, suggesting that crypto’s correlation to macro is not going away anytime soon.
• We continue to monitor the discount to NAV of GBTC, Grayscale’s bitcoin trust, which has compressed from nearly 50% to 35% at the time of writing. It could very well be the case that inflows are due to speculation of an impending redemption event.
• This week’s follow-through in price action is certainly encouraging, and barring any forced liquidations from DCG, there is a high probability that the absolute bottom is in for crypto prices.