Stocks at a Crossroads

Stocks at a Crossroads

May 19, 2022
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In the spotlight today: economic expectations due to domestic retailer weakness, sentiment, and valuations — the big things you need to know:

  1. The S&P 500 is still trading as though it’s experiencing a growth scare, a framework that has been pointing to a downside in the S&P 500 to roughly 3,850. Current trends in economic forecasts continue to support the idea that this is the right way to think about how far stocks should fall, though we remain mindful that could change. The news almost always precedes the action.
  2. Institutional investor sentiment has made significant progress catching down to retail investor sentiment, with overall US equity futures positioning among asset managers now below 2020 & Great Financial Crisis lows and getting close to 2011 and 2015/2016 lows – something that makes the case for a bottoming in stocks relatively soon if recession fears can be kept at bay. We continue to keep a close eye on equity put/call ratio, as well as crypto, which we view as important sentiment barometers.
  3. While valuations aren’t yet a reason to buy US equities on their own, they are no longer a problem for the market as a whole. With last week’s sell-off, top-down trailing and forward P/Es for the S&P 500 have broken below their long-term averages and the relative P/Es of the most popular hedge fund stocks have also returned to 2018-2019 levels.

The S&P 500 Is Still Trading Like We’re Experiencing A Growth Scare

Despite how much worse the tape has felt, the S&P 500 closed on Thursday just 18.1% below its early January high. With that move, the S&P 500’s decline has been a little worse than the average post-GFC (Great Financial Crisis) growth scare (the declines of 2010, 2011, 2015-2016, and late 2018), but not quite as bad as the more extreme ones of 2011 (-19.4%) and 2018 (-19.8%). The duration of the early 2022 drawdown (129 days) is also getting close to the average duration of the other major post-GFC growth scares (147 days).

As we’ve highlighted before, if the S&P 500’s decline this time around matches the late 2018 drawdown, the index would fall to around 3,850, a level that the S&P 500 came close to hitting but failed to breach intraday on May 12th. In this context, we think the S&P 500 is currently at an important crossroads. If 3,850 doesn’t hold, we think the equity market will be telling us that it’s starting to price in a recession. If that happens the key number to keep in mind is 3,200 which would represent a 32% drop from the January high – right in line with the average drawdown seen in past recessions.

Though we remain mindful that the risks to the economy have grown, it makes sense to us that the S&P 500 is attempting to stabilize just as it is approaching the outer band of growth scare territory. While recession expectations among economic forecasters have inched up recently per Bloomberg, they are still only on par with another post-GFC growth scare (2011). GDP forecasts on the Street have been pulled down but are still slightly above trend for 2022 and are still north of 2% for 2023. US economic surprises remain in positive territory. High-frequency economic indicators like dining, flying, back to work and same-store sales remain stable. Freight rates have come down sharply from their highs. Inflation expectations are retreating.

We don’t blame the stock market for wanting to see evidence of an unraveling before pricing it in, given how frequently the economy and US consumers have been more resilient than expected in recent years. As for the Fed and the fear that they will tighten too aggressively, our economics team noted last week that “It’s fair to wonder if the Fed will even get to neutral. We think Powell is growing worried about the degree to which the economy is going to slow.”

While retail investor bearishness on equities has been extreme, such that it has been sending a contrarian buy signal for the S&P 500, that simply hasn’t been the case for institutional investors. And it may have simply been that in order for the US equity market to find a bottom, institutional investors have needed to catch down to retail.

Today, there’s been no meaningful change in the sentiment for retail investors, where net bearishness remains at the deepest levels we’ve seen since the Financial Crisis. Important progress has been made on the institutional side, however. The main way that we monitor institutional investor sentiment is by tracking the weekly CFTC data on asset manager positioning in US equity futures. Importantly, when we aggregate the data for all of the major contracts, we find that positioning is now below 2020 and GFC lows. Though it’s still technically above 2011 and 2015/2016’s lows, it’s gotten much closer to them.

it’s also worth noting that the relative P/E multiples of the baskets of the most popular stocks in hedge funds that we track (as measured against the median S&P 500 stock) have returned to 2018-2019 levels, though not pandemic lows. While valuations aren’t a reason to own US equities yet, they are no longer a reason to avoid them. A recent story I heard was that in La Guardia airport, one beer is now $27.00. That’s right, for a beer! I won’t even go into how freight rates are coming down as diesel fuel makes the cost to fill up a trucker’s tank over $1,100. Something has got to give. It surely doesn’t bode well for increasing taxes nor for further government involvement in public company management.

As the old saying goes, “it is always darkest before the dawn.” I don’t know when the sun will shine again, but I do know that in looking at most prices, it is pretty dark out there right now. At the same time, I am writing this to provide some level of perspective. I don’t like to be negative, but at times honesty is clearly the best policy.

Please have a nice weekend but save it up for the holiday weekend next week. It is well deserved by all!

 

 

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