At the start of 2023, the street consensus was bearish on equities; both institutional investors and the man/woman on the street were not excited about the year to come. I began 2023 by giving historical statistics of what changes were happening in the markets and then of late (since the last interim top on February 2) the negatives that the negative nabobs were espousing. The most recent one being the massive earthquake in our banking system that came to a crescendo on March 10th with the failure of Silicon Valley Bancorp. I do not intend to dwell on the banking issue anymore as the markets are telling us that the problem was clearly real but has been contained by our Federal Reserve and FDIC. But as I have been stating since the end of the first week of 2023 in our 2023 missives, I wrote how probabilities favored S&P 500 gaining >20% (>4,750 by YE) with multiple factors driving this view. Take a moment now to look at the table I have included below. I also implore you to go to our site and refresh if you would like on the statistics, but I want to give you a quick bullet-point list of what is going on TODAY!
- As of the start of April, S&P 500 has risen +7% year to date. This is the strongest start since 2019.
- The newest factoid: S&P 500 has now posted two consecutive quarterly gains (last quarter of 2022 and first quarter of 2023), which has NEVER happened in a bear market (since 1950), meaning 1Q23 gains validate a bull market started on Oct 12, 2022. I say this date as this was the date that the S&P 500 printed its lowest low in this cycle so far. S&P 500 has been rising for 6 months and all the while, in measurements of the AAII studies, investors are more bearish (negative) now than they were in October 2022.
These negative investors are getting increasingly trapped as their fundamental catalysts for stocks to decline have passed without a negative outcome and equities have shown impressive resilience. These negative catalysts were:
– Inflation was supposed to accelerate in 2023, but it is now cooling sharply.
– EPS estimates for companies of the S&P 500 were supposed to tank but have been leveling off.
– Regional banking crisis was supposed to tank the economy, but it is leveling off too. This is measured by credit spreads and the costs of Credit Default Swaps (cost for banks to ensure their credit).
– Fed was supposed to become more “hawkish” and seemed possessed to raise rates aggressively. This was evidenced by the last comments out of Fed Chairman Jerome Powell just two weeks before the Silicon Bank failure. But instead made a “dovish” tack. It could be that the additional fear and trepidation caused by the few bank failures have actually acted like a rate hike in the psyche of the investor. See below what he has done and what he is expected to do along with what is going on in England (BoE) and Europe (ECB).
- – Long-term yields were supposed to soar but have fallen consistently since February. This has actually been seen at most maturities beginning as short as the two-year.
- In other words, bearish catalysts have come and gone, and S&P 500 is up +7% YTD.
- What about April? Based on history, we expect April to be the strongest month in 2023, mainly relying on the implied gains using the “Rule of the first 5 days.” The "Rule of 1st 5 days" looks at years when S&P 500 gains more than 1.4% in the first 5 days and is negative the prior year. This has happened 7 times since 1950: 1958, 1963, 1967, 1975, 2003, 2012 and 2019.
- Based upon those 7 years, April implied gain is +4.2% and was positive 6 of 7 times (only 2012, -0.7%). This implies +175 points, or S&P 500 >4,275 by the end of April.
Is S&P 500 exceeding 4,275 consistent with investor positioning today? Nope.
Now let's take this point one step further. IF this is true, and IF this has happened 7 times since 1950, what does the rest of the year possibly look like?
Now let's talk about the inflation readings again. Remember, according to Fed Chairman Jerome Powell, he remains "data dependent." And his two hot points of choice are labor and the PCE. February's PCE deflator (personal consumption expenditures) was reported last Friday, and this showed solid progress on inflation. Most notably:
- “Super core” or core services ex-housing was only up +0.27%.
- This is the slowest since July 2022.
- This is an annualized rate of 3.3% (4.8% 3M annualized).
- The trend is visibly improving for this core services ex-housing, which is the particular focus of the Fed at the moment.
The next measurement is the University of Michigan consumer inflation expectations. This measure fell again and now sits at 3.6% (year ahead), the lowest reading since April 2021. This appears to be a sign how far inflation expectations for households have fallen. In fact, this now sits over 200bp (2%) below the current official CPI measure. So, doesn’t this suggest CPI itself might be statistically lagged? Again, refer to the first illustration in this note to see what the course of CPI is expected to be.
In closing, it increasingly looks like “bears are trapped” praying for new lows
The first quarter of 2023 (1Q23) came to a close Friday and despite a wrenching banking crisis, the S&P was up again for the month of March. Many skeptics (anecdotally, the majority of both institutional and individual investors) are likely scratching their heads at these gains, as mere noise until the 2022 bear market re-asserts itself. But for reasons outlined above, we believe 1Q23 gains now solidify that “bears are now trapped” — meaning, our analysis suggests that the “lows are in” (10/12/22) and these gains should continue in April:
- The banking crisis is looking more like a “clean up in aisle 7” (Mr. Mom, 1983) than a full-blown crisis. Granted, regional banks are languishing, but the crisis is not widening to a broader loss of confidence in the banking system. This started with a “social-media” induced (generated) bank run and those runs have not continued.
- Second, the Fed made a “dovish hike” in March as consumer inflation expectations now stand far below reported CPI — U Mich. mid-March +3.8% vs Feb CPI +6% YoY. This is the largest negative spread (-220bp) since late-1982. This gives confidence to the Fed to “tolerate” CPI reports as consumers see far less inflation. See the 3/31 chart above.
- Third, S&P 500 has now posted two consecutive quarters of gains:
– 4Q22 +7.1%
– 1Q23 +5.5%
– Over the past 50 years, two consecutive positive return quarters have never been seen in a “bear market.”
– This 50-year fact was not seen in the GFC (2007-09) nor “dot-com” (00-03) nor Volcker bear (81-82) etc. Just to point out huge points of financial stressors. - Fourth, seasonals favor April gains. We have used the “rule of 1st 5 days” as a guide for 2023. This rule (1st 5 days >1.4% plus neg prior year) implied +2.6% gains for March and March 2023 tracking +2.1%, so very close. This same analysis suggests April +4.2%, or >S&P 500 4,200. This would put YTD gains at ~10%.
- Fifth, institutional investor positioning points to gains in April. CFTC (Commodities Futures Trading Commission) data shows speculators are still short 202,000 futures contracts on the indexes, verifying the bearish positioning in place since October 2022. Notably, some bears are beginning to exit the “trap” — Michael Burry @michaeljburry last week tweeted “I was wrong to say sell” (which he did in January 2023).
2023 has clearly started far differently than last year. Will it continue as the statistics say it should? Well, it might, but if Mr. Market does his normal thing, there will be fits and starts, but in the end, we should end up with an outcome far different than what occurred last year. Stay tuned!
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