Published April 28, 2023
Below is Delta Research’s take on the current market conditions. Volatility has plunged from the bank crisis in March and is approaching the low end of its range for the post-pandemic cycle. Following Delta’s review, we post a more bearish, fundamental driven, outlook from Bank of America as an example of the type of bearish thinking Delta refers to.
“Perception plays an important role in how investors see the world. Investor allocation to equities relative to bonds has dropped to its lowest level since the Global Financial Crisis (GFC, 2008-09) as worries about a recession take hold, according to Bank of America Corp.’s global fund manager survey. J.P. Morgan’s manager survey shows 68% of managers are more likely to decrease equity exposure over the coming days/weeks. Equity investors are mostly bearish.
Investors with a bearish outlook tend to attach more importance to negative news than positive news as negative news reinforces rather than conflicts with current beliefs. So, despite positive earnings reports from bellwether companies including Microsoft, Google, Meta, PepsiCo, Coke, JP Morgan Chase, 3M, General Motors, Halliburton, Kimberly Clark, McDonald’s, Raytheon, Enphase, Visa, Automatic Data, Boeing, Boston Scientific, Otis, Aflac, KLA Corporation, O’Reilly Auto, etc., two reports placed downward pressure on the market this week.
Bear Report 1: Coming into this week, First Republic Bank (FRC) stock had already depreciated by about 88%. In the wake of their earnings report on Tuesday, the stock dropped an additional 67% to an all-time, single-digit low. The First Republic fiasco knocked the regional bank sector down and renewed fears of recession caused by tighter lending standards.
Bear Report 2: UPS reported in-line earnings but lowered its full-year guidance due to macroeconomic conditions and “changes in consumer behavior.” They also materially guided down Q2 Expectations. The stock lost 10% of its value on Tuesday and renewed fears of recession.
The FRC/UPS one-two punch dropped the S&P 500 by about 2% over two days.
Trend following investment programs require a durable trend to follow. For much of the past year, the S&P 500 has been range bound in a sideways wave pattern, with every potential trend, both up AND down, fizzling out. A choppy market environment can create whipsaw trading until a more lasting bull or bear trend is established.
The reason why the market is moving sideways is because of high uncertainty regarding the direction of economic growth and earnings in the near to intermediate term. Pessimism is the consensus view currently. This statement, in and of itself, is bullish.
Because the bullish case is contrarian, it is more interesting. It also has the capacity to move the market more impressively. Outcomes that are not expected are more market moving.
A bullish case can be made with respect to inflation. There are signs that inflation has been tamed. The Philly Fed Prices Received Index shows zero inflation today.
The chart below shows the S&P 500 Total Return Index for 24 months following the inflation peak. In all cases, the Index trends higher. It does best when the inflation peak is not followed by recession but even a recession does not eliminate all appreciation typically. The red line on the chart shows our current progression assuming inflation peaked in the middle of 2022.
With uncertainty elevated and the market advance stalled, tactical traders move back into a wait and see mode. For buy-and-hold investors, it is reassuring to see so many positive earnings reports from such a broad array of industries. It is also encouraging that the S&P 500 has appreciated over time following an inflation peak even with a prevailing headwind of bearish sentiment. If a recession is still ahead, the stock market could continue its rather sideways trading for awhile to come, similar to the orange line above.”
Now, from Bank of America’s Michael Hartnett: the message being sent to the Fed from the market is somewhat confusing reckons Michael Hartnett, investment strategist at Bank of America Securities. In his weekly Flow Show note that landed early Friday, Hartnett lists a slew of factors pointing to a recession.
For first time since 1981 every U.S. yield curve has been inverted for over 6 months, he says, and in past 100 years the current 170 basis points of inversion between the 3-month & 10-year yield has been exceeded on just 125 days.
Such a move suggests a recession is imminent, says Hartnett, who offers up more signals supporting this scenario.
Oil “can’t catch a bid” despite recent OPEC supply cuts and big a U.S. inventory drawdown. Taiwan, the world’s biggest chip maker recorded industrial production down 15% in March — traditionally a good global recession indicator — while China’s imports have started to decline despite the recent post-COVID reopening.
In addition, the latest U.S. ISM manufacturing reading of 46.3 is nearing the 45 level that in the past 70 years has always delivered a recession; housing prices are falling across many developed markets; and lending standards to small U.S. businesses are the tightest since 2012, and set to tighten further as growth in U.S. M2 money supply of -4.1% is the most negative since 1933, he says.
And yet, fiscal policy remains very stimulatory, Hartnett notes, while labor markets across the G7 economies remain tight. “U.S. initial jobless claims, arguably best coincident indicator of growth, fell last week to low 230,000, and unemployment is largely confined to banking and technology states of CA, NY & MA, [making up] 40% of initial claims,” he adds.
In summary, Hartnett says the expected macroeconomic and market chronology of past 18 months — inflation shock, leading to rates shock, a bear market, a recession, Fed cuts and then a bull market — “has been interrupted.”
Still, the strategist remains bearish, as he predicts the “economic ambiguity of 2023” will end with cracks in the jobs market and an earnings recession. Hartnett’s advice is to sell the S&P 500 if it gets above 4,200 as stocks are only pricing in an earnings per share decline of just 4%, while the market is also expecting “210 basis points or rate cuts peak-to-trough. A dramatic fall in wage inflation [is] key to ‘soft landing’ upside, but we think risks of hard landing for EPS /no landing for interest rates remain high.”
Investors looked this week to earnings announcements from most of the megacap tech companies that dominate the stock market indexes. Ahead of those results, Monday provided another quiet, flat trading session. The quiet was upended Tuesday when First Republic Bank reported a shocking $100B outflow of deposits over the past month. That news coupled with a report from UPS warning of weakening “macro conditions” that will negatively impact package volumes for the delivery and transport company. UPS shares slid -10% on the news while First Republic shares plunged below $10/share after being priced at $140/share in January. Broad market stock indexes suffered 1-2% declines on Tuesday’s news. Stocks dipped another -0.4% Wednesday despite a strong +7% gain in Microsoft on better results. Alphabet(Google) noted slipping business activity but also did better than forecast to help contain the broad market’s losses. Meta/Facebook delivered a substantially positive earnings report to boost the market Thursday. Stocks rallied +2% to recover the losses earlier in the week. Stocks continued the momentum in Friday’s trade with indexes tacking on another +0.7% to close the week with slim gains. Intel delivered weak results, but again the market viewed the news as better than expected. Oil companies Exxon and Chevron reported another quarter of massive earnings while the latest inflation report showed a continued downward slope in prices.
Investors displayed bullish action this week as an early selloff was bought by investors to ultimately send the week higher by +0.90% on the S&P 500 (SPY). The move left the index at its high for the year. The Nasdaq 100 (QQQ) added +1.90% this week to close above the $320 level for the first time in a year. Smallcaps (IWM) reflected the wide discrepancies in the market with a losing week, down -1.32%. Smallcap indexes do not have the benefit of the megacap tech companies which have been major drivers of the lift in the market this year. Midcap and smallcap indexes are little changed on the year.
Warm wishes and until next week.