Stocks Finish Week Strongly, With Nasdaq Up for Three Straight Weeks
Our Views
Incoming economic data on 1/18 was positive on the inflation front (PPI) and mixed on the demand/volumes side. We saw a rapid decline in inflationary pressures for producers.
- Dec PPI core came in at +0.1% vs +0.4% last month and 3M annualized is 2.16%, pretty consistent with 2% Core CPI.
- Retail sales were soft with ex-autos and ex-gas at -0.7% vs 0.0% expected but this is not entirely surprising.
- NAHB was a positive surprise coming in at 35 vs 31 expected.
As shown below, PPI core is falling like a rock (3M annualized).
PPI leads CPI: This has been the case consistently
Of these, we view PPI as the most important. As shown below, the PPI Finished Goods and CPI move in tandem and our data science team notes that PPI Finished Goods leads CPI. Hence, a downturn of PPI Finished Goods of this magnitude points to a sizable drop in CPI in coming months.
But this drop in PPI Finished Goods also portends downside to EBIT margins coming for S&P 500 companies. This is reflected below, and it is evident that there is a general directional relationship between PPI Finished Goods YoY and EBIT margins. However, the key is the sector and industry sensitivity, and this is more important, arguably, than overall S&P 500 EBIT sensitivity.
As shown below, the sectors most correlated on EBIT-margin basis to PPI are:
- Real Estate
- Energy
- Basic Materials
Those that are Inversely correlated are:
- Utilities
Those with little correlation:
- Technology
- Discretionary
- Communications Services
- Financials
- Staples
So overall, the groups most vulnerable to potential EBIT pressures are commodity-related groups, not surprisingly. A distant second is Industrials.
Inflation itself has hit a wall, as 59% of CPI components are in outright deflation. On a weighted-basis, this is now 34%, solidly above the 30% 50-year average. We crossed that point in December 2022. Then-Fed Chair Paul Volcker ended his war on inflation in October 1982, when this diffusion measure rose above 30% (see below), so Fed is now in the same place.
- We have been regularly updating the diffusion of CPI below. This index, created by our head of data science, “tireless Ken,” tracks the % of CPI components in outright deflation.
- The top is % of components and is at 59% vs 50% 50-yr average
- The bottom is % of CPI basket (by weight) is at 34% vs 30% 50-yr average
- Both are well above the long-term average
The weighted basis is particularly eye-catching. As shown below, this is a solid recovery of this diffusion measure, after spending 2021-2022 at the 20% level. When it was at 20%, this meant that 80% of CPI components were inflating (weighted-basis) which is why inflation was so prevalent.
In October 1982, this figure crossed back above 30% after spending >12 years below this line. That is when Volcker ended the inflation war.
If this is a 1982-moment, then it is necessary to recall – as we did in our 2023 Outlook – that the stock market was two months ahead of the Fed in 1982, rallying well ahead of the Fed.
- The S&P 500 fell 27% over 27 months into August 1982
- Stocks made the “final low” on 8/12/82
- Fed Chair Volcker did not even posit ending the inflation war until Oct 1982, or 2 months later
By the time Volcker spoke of this, the S&P 500 had nearly erased the entire 27 month bear market, and a new all-time high was made within 4 months of the low. This is a possible path for 2023.
- A lift in the SPX hasn’t improved short-term technical structure, and a rally back over 4035 is required to have confidence that a large rally is getting underway.
- Sector rotation shows a big period of outperformance from last year’s laggards. I will be unveiling my sector over/underweights next Tuesday during my Annual Technical Outlook webinar for 2023.
- Natural Gas looks to be close to bottoming out; gains likely into April 2023.
- Did we just get an important change in the equity market backdrop where bad news is bad news this week? It is too early to make this call, but my work suggests it’s time to be on the alert for the U.S. economy to start showing more signs of weakening.
- Along with some early signs of cracks for the growth outlook, Fed speakers have been quite consistent that more work needs to be done, and that retaining the terminal rate unchanged for an extended period is still the base case.
- With that being said, there remains a significant gap between market expectations for monetary policy going forward and what the FOMC has been forecasting and communicating. Who will end up being right? Yes, the headline and goods inflation readings are falling and should continue to do so for several months, which support the view for the Doves. However, the labor market/wage data remains quite resilient. This week’s initial jobless claims fell below 200k, providing no evidence of the slack that has been communicated by Chair Powell and Gang as an important objective. The Hawks, including myself, are likely to keep pointing to this as proof that the Fed will be higher for longer.
- My works continues to suggest that the Fed’s bar for pausing and flipping back towards accommodation is quite high and that the market remains overly complacent. With my ongoing view that forward profit expectations remain too high and with a Fed that is unlikely to be quick to ride to the rescue on their white horses, I continue to see considerable downside risk for the equity markets.
- Did we just get an important change in the equity market backdrop where bad news is bad news this week? It is too early to make this call, but my work suggests it’s time to be on the alert for the U.S. economy to start showing more signs of weakening.
- Thus, I continue to reiterate that patience will be needed during this tug-of-war period and that strategic investors should view tactical bounces as bear-market rallies that will likely fail and use them to sell into, reposition, raise hedges, and to reload shorts.
- Stocks are still expensive when compared to investment-grade bonds, but this situation continues to improve.
- Equities are likely to decline in the near-term, but if yields were to fall closer to 3%, that would make stocks look more attractive.
- Yesterday, we held our annual Outlook call in which we discussed the carnage of 2022 and reasons to be optimistic about 2023.
- We think that the majors have seen their absolute cyclical lows. This rationale is supported by (1) the nature, magnitude, and duration of the drawdown since late 2021, (2) volatility having churned in recent months (crypto often bottoms on boring), and (3) on-chain price discovery that has transpired for bitcoin around the $16.5k level.
- Coupled with structural tailwinds and catalysts mentioned, we think that bitcoin will see $35k – $44k this year and ETH will see $2,400 – $3,200. These prices are supported by applying conservative assumptions around capital inflows projected MVRV multiples.
- Some of the key narratives we will be watching in 2023 include anticipation of the next BTC halvening, Shanghai upgrade enabling staking withdrawals, and EIP 4844 leading to increased value accrual at the scaling layer.
- The debt ceiling has been reached but might be managed through “extraordinary measures” for several months.
- Congress tends to wait for deadlines before acting, so it is unlikely that a deal to raise the ceiling will be reached before a concrete date for default is determined.
- House Republicans have begun their planned series of hearings on issues they hope will hurt Democrats in 2024 and embarrass the Biden administration.
Wall Street Debrief — Weekly Roundup
Key Takeaways
- The S&P 500 ended the week at 3,972.61, down 0.66%. The Nasdaq ended 11,140.43 up 0.55%, its third consecutive week of gains.
- Investors continue to worry about the state of the economy and what the Federal Reserve will do next, but markets have been robust so far in 2023.
- The debt ceiling has officially been reached, but extraordinary measures are expected to stave off any risk of the United States defaulting on its obligations until sometime in June.
Good evening:
Major market indices slipped slightly at the beginning of the shortened trading week, fell more sharply on Wednesday and Thursday in response to recession worries, and finished by rebounding on Friday. Investors worried that the Fed would overtighten in its inflation battle, despite increasingly visible progress. This week, December PPI core came in at +0.1% vs +0.4% last month. Headline PPI also fell, coming in at 6.2%, down from November and below expectations of 6.8%.
However, Fed officials continued to warn that the fight was not over. Vice Chair Lael Brainard said, “Inflation remains high, and policy will need to be sufficiently restrictive for some time.” Similarly, Federal Reserve Governor Christopher Waller told an audience at the Council for Foreign Relations in New York that “we still have a considerable way to go,” though he confirmed his support for a 25bp increase at the next FOMC meeting.
Disappointing retail numbers for November and December contributed to worries about the economy. Data showed that retail sales slipped in December, falling 1.1% from November to $677.1 billion. Economists were forecasting a contraction of 0.8%. Retail sales during November and December grew 5.3% year over year to $936.3 billion, failing to keep up with inflation and coming in below expectations of YoY growth between 6% and 8%.
At our weekly research huddle, Head of Technical Strategy Mark Newton noted that 2023 has begun with “a far more robust rally” than many expected. He pointed out that the midweek declines in major market indices were misleadingly skewed by the underperformance of the Technology sector, which is overweighted in the major indices. Newton observed that many other sectors have risen strongly this year—particularly those sectors that were laggards in 2022, such as Consumer Discretionary, Communications Services, Materials, and Real Estate.
Treasury Secretary Janet Yellen on Thursday told Congress that the United States had officially hit its $31.4 trillion debt ceiling, as she had warned last week. This is likely to set up a prolonged partisan fight as Republicans seek to tie the approval of any debt-ceiling increase to commitments to cut government spending, while Democrats will try to resist tying any conditions to the increase. Fundstrat’s Washington Policy Strategist Tom Block said, “Republicans seem to have dug themselves into a hole that is almost impossible to get out of,” in part because the promises Speaker Kevin McCarthy made to a small contingent of his party to secure his position lack support in the Senate and the White House.
Since 1960, Congress has raised the debt ceiling 78 times, including twice during the Trump administration—generally with little fanfare. Initial market reaction to the pending standoff seemed mild or non-existent, perhaps because the United States is not in any imminent danger of defaulting on its debt.
Nevertheless, Block has previously described raising the debt ceiling as “must-pass” legislation.” JPMorgan CEO Jamie Dimon put it more strongly this week, as he also did in 2011 when the debt-ceiling debate led to Standard & Poor’s lowering the U.S. credit rating for the first time ever. On Thursday, Dimon said: “We should never question the creditworthiness of the United States government. That is sacrosanct. It should never happen [...] Even questioning it is the wrong thing to do. That is just a part of the financial structure of the world. This is not something you should be playing games with at all.”
Elsewhere
China’s 2022 economic growth fell far short of Beijing’s target, hitting 3% rather than the 5.5% for which the government was hoping. It was also far lower than the 8.1% growth China notched in 2021. With the exception of 2020, it was the worst economic number China has seen since 1976, the year Mao Zedong died.
More worrying in the long term, China this week officially reported its first population decline in six decades. The traditional challenges posed by a population decline–which are invariably accompanied by an aging population–are likely to be exacerbated by the country’s unusually low retirement age of 60.
Speaking of retirement ages, members of multiple labor unions throughout France went on strike on Thursday in response to President Emmanuel Macron’s attempt to raise the country’s retirement age from 62 to 64. Teachers and employees of railroads, oil refineries, and public radio stations walked off the job. Employees at EDF, France’s national electric utility, intentionally lowered the country’s power output. As many as 1.2 million critics of Macron’s proposal marched in protest, demonstrating once again why retirement reform is seen as the third rail of French politics. Another day of strikes is planned for January 31.
Japan reported that YoY inflation in December reached a 41-year high of 3.8%. The Bank of Japan nevertheless said it would maintain the country’s ultra-loose monetary policy, continuing to buy bonds in its efforts to control its yield curve.
And finally: This Sunday, January 22, marks the Lunar New Year, which is celebrated in a number of countries in East and Southeast Asia. It will be the Year of the Rabbit and, according to our Head of Data Science “Tireless” Ken Xuan, Rabbit years have historically seen the strongest stock-market returns out of any of the 12 animals. “Gong xi fa cai” to all!
Important Events
Est.: 2.5% Prev.: -2.1%
A measure of new orders placed with domestic manufacturers for the delivery of long-lasting (three years or more) manufactured goods.
Est.: 205K Prev.: 190K
The number of initial or new claims for unemployment benefits across the United States.
Est.: -0.1% Prev.: 0.1%
Also known as personal consumption expenditures, this is a measure of the goods and services purchased by, or on behalf of, people living in the United States.
FS Insight Media
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