Stuck Between A Bear And A Bull

Stuck Between A Bear And A Bull

March 01, 2023

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We are at the end of the second month of the new year. A year that has started far differently than 2022.

As of last Friday (2/24), 94% of the S&P 500's companies had reported their Q4 2022 earnings. Here’s what we know.

  • Earnings growth was off by 3.22% on the back of 5.65% revenue growth.
  • Four of the 11 S&P 500 sectors posted positive earnings growth.
  • Energy, Industrials, and Consumer Discretionary show double-digit earnings growth in the period. Even the real estate sector posted single-digit growth for the period.
  • Stock and bond prices moved lower last week after enjoying several weeks of gains from December lows. Increased concerns about inflation tied to economic data served as the major catalyst.

In previous reports I have gone into the trifecta of market actions that have historically, with high probability, precluded quite impressive full-year performance:

  • Santa Claus Rally last week of 2022
  • Stocks gained over 1.4% on the first 5 trading days
  • The first 6 weeks of the year show an almost straight-up increase.

While markets have been up (seven out of seven times) for 3 months, 6 months, and a full year when these sets of facts have aligned themselves, it is quite customary for the markets to have a brief digestion following a strong up move that has taken prices to a somewhat "overbought" level.

Bottom line: We believe that markets are in a consolidation period, but this should end in the next week or so. This would coincide with incoming economic data that could show that January was an anomaly and not the strong rebirth of continued inflation.

But, as we know, financial markets are data-reactive. They will react quickly to what they either don't expect or what is better / worse than what was expected.

What we have experienced in February is what I would call a "payback" period. Due to stronger economic reports from labor numbers, Consumer Price Index numbers, and Producer Price numbers, interest rates took a break from their decline and inched back up.

Statistically, using the "rule of the first 5 days (mentioned above), the "payback" period should have started around the time it did, and it should exhaust itself sometime around the end of the first week of March (source: FundStrat Research). Going back to 1950, here is the typical "payback" illustration:

If we overlay an even more exact picture of the current market, we see that the decline started around February 11th, and it should track to March 7-10th. This is an even more concise correlation as it takes into account the entire trifecta market checklist I bullet-pointed at the beginning of this note:

These two charts look very similar, but there are subtle nuances that I think warranted both being illustrated here. After this "payback" period, markets tend to then have experienced a period to revitalize their internal strength and continue with the expected course of direction.

Remember, 7 out of 7 times the market has ended the year higher ranging from +13% to +38%. The two most recent being 2012 and 2019 (source: Bloomberg). I have taken the liberty of including all 7 years and returns in the table below. Outsized returns seem to be more the rule than the expectation:

The issue that is on the media's tongue and that seems to be scaring almost everyone though is the fear that the Fed might have to raise interest rates higher for longer. Since the interest rate hikes have been the instigator of the 2022 market decline, the media has investors on edge fearing a new low in the markets and a continuation of the decline of 2022 rather than a confirmation of the second-year data I have shown above.

I believe we had a string of disappointing inflation reports from the CPI, PPI, Labor, and most recently PCE last Friday. But what they all have in common is that they are all a backward-looking view. If we are to focus on a forward-looking view, inflation indicators do not seem to be showing any signs of revitalized concern.

To find forward-looking data, I focus on the commodity benchmarks. Remember that commodity prices are quoted in "futures" market prices, where they are reflecting what is being paid for various commodities in the future.

Think of Kellogg's locking in the future price of corn for their cereal production. They wouldn’t be able to know how to price the cereal to the supermarkets if they didn’t have their future costs of goods locked in. In looking at the broad indexes, the GSCI, the CRB, and the Bloomberg commodity indexes- none of them are at levels that are currently feeding into the inflation pressure narrative. 

One last point is that of the labor number. Three Fridays ago, we got a spiking labor number that showed a large uptick in the number of service workers. Could it be that these service workers that were living off their government subsidies post-COVID are finally running out of these savings and now must go back to work? I believe that this idea is confirmed by a large increase in credit card borrowing.

Putting all these forward-looking indicators together, I still see no reason for the Fed to panic and overtighten. Federal forecasts show the unemployment rate increasing by 1-2%, causing three million people to lose their jobs. 

Of course, this has not shown up yet in any of the official employment statistics, but employment reports are lagging information. To look at the leading side of employment data one might want to focus on job recruiting as this reflects what companies are putting out there to reflect their hiring intentions.

According to Jeremy J. Seigel, "Peter Boockvar summarized the ZipRecruiter conference call and notes that ZipRecruiter’s revenue was down 15% in January, and they have many more job hunters, with a sharp pullback in jobs listings. This could be an early sign for what is to come in the official statistics."

In closing, as I explained in detail last week, February tends to normally be a "seasonal detour." To the neigh sayers, a continuation of the decline.  To current trend followers, a pause that refreshes. The market roadmap is still intact. Does this "payback" period tend to derail what has historically been a favorable seasonal road map? No, not by our analysis, instead it tends to represent a pause that refreshes.

I will finish with an update to the US Presidential Cycle: First Term Presidents, going back to 1929:

Of course, every time is a bit different, but if we rely upon history while at the same time being careful and alert to changes/differences "this time" we should be able to continue to navigate through these often hand-wringing times.

March seems to have been a month where after the February breather things could get back on track. We will follow the tea leaves of inflation, bonds, the US Dollar, and commodities to see if this is the case. Please feel free to call should you have any questions or concerns. As always, we are here to answer any of your questions.

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

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