RapidEye
Thesis
A weak finish for the S&P 500 (SPX) (SP500) (SPY) (VOO) and the Dow Jones Industrial (DJI) (DIA) to end last week’s trading, as traders/investors de-risked their positioning ahead of the Fed’s decision week on interest rates.
Fed Chair Jerome Powell will hold his highly-anticipated press conference on December 14, with sufficient time for the FOMC to parse the release of November’s CPI print on December 13.
The NASDAQ (NDX) (QQQ) finished well, even though its recovery has lagged behind the SPX and DJI since their bottoming process in October. We gleaned that the DJI has outperformed its peers as it broke above its August highs to form a bull trap, coupled with a sharp momentum spike.
Despite that, we assess that DJI’s double-bottom bear trap at its October lows is constructive, and we don’t expect it to re-visit its October lows, even though we think a healthy pullback is overdue.
Hence, we deduce that the market’s cautious positioning ahead of next week’s critical data releases is justified. The market needs to know how last week’s higher-than-expected PPI release could alter the Fed’s revised dot plot, with the economists’ consensus pointing to a 5% terminal rate until the end of 2023 before easing.
Data releases on the housing and rental market suggest it could be less of a headwind moving ahead, which may not yet be reflected in November’s CPI print. However, services employment continues to be robust, and the economy’s overall jobs growth remains strong, despite the recent tech layoffs. Hence, the employment picture could keep the Fed on its toes, with the market keen to assess Powell’s commentary on the FOMC’s most updated guidance.
Valuation on the SPX and the DJI continue to be constructive, despite the increased likelihood of a global recession. While not cheap, we believe that SPX’s October lows should hold robustly if the economy does not fall into a severe recession. Hence, a pullback to digest its recent surge should improve reward/risk and give dip buyers another opportunity to strike, anticipating the SPX’s October bottom to be sustained.
Our price action analysis suggests caution on the DJI and SPX but sees more constructive action on the NDX, which appears primed for outperformance.
Market strategists have moved their concerns about an increasingly hawkish Fed to a less hawkish Fed, seeing a slower rate hike cadence corroborating their recessionary outlook. Amazingly, they now think that “bad data/less hawkish Fed” indicates trouble for the economy. Many point to the steepest yield curve inversion in decades as a sign of problems ahead and thus have become the most pessimistic in over two decades.
We urge investors to remain near-term cautious on the DJI and SPX, with both primed for a healthy pullback. While the NDX would not be immune to a broad market pullback, we are more constructive over its price action.
Market Strategists Are Now Worried About A “Less Hawkish” Fed
Not too long ago, economists were looking for “bad data” suggesting inflation could cool fast enough to spur the Fed to slow down its rate hike cadence.
With the Fed likely looking at a 50 bps hike at the upcoming FOMC (and the market has also priced in a 78% probability of a 50 bps hike as of December 9), we found it interesting that some of these economists now think that bad data is indeed bad for the economy. Academy Securities highlighted:
We will shift from seeing ‘bad data’ as being ‘good’ to bad data [as] being bad because it is a signal the economy is weakening faster and worse than most expected. – Bloomberg
The shift in perspective is not surprising, as a recent Bloomberg compilation indicated that strategists are at their most pessimistic levels “since at least 1999.”
Furthermore, the IMF and World Bank added to the pessimism as they anticipate worse economic risks, despite a recent revision in October. The IMF highlighted that “further downgrades to global growth are likely.”
Hence, investors should be expecting more “bad data,” literally meaning “bad news” calls in the media over the coming weeks/months. However, the critical question is whether such pessimism has been priced in accordingly.
Still, There’s Hope In 2023
Fund managers polled by Bloomberg in a recent survey expect that inflation has likely peaked, and therefore, investors should expect more relief in 2023. The consensus estimates suggest an average gain of 10% in 2023.
Hence, we assess that fund managers are increasingly confident that the market has likely priced in the recessionary tunes to a “certain extent.” For example, Sweden’s largest fund manager Swedbank Robur articulated:
Even though we might face a recession and falling profits, we have already discounted part of it in 2022. We will have better visibility coming into 2023 and this will hopefully help markets. – Bloomberg
Also, not all market strategists are so pessimistic. The Leuthold Group Chief Investment Strategist even telegraphed an SPX 5,000 possibility, as it articulated:
If you think the bear market is not over, I get that and that’s one thing. I think the lows are in, and I think we’re starting a new bull market. If … we are past the bear and we have a modest or no recession and [start] a new bull, I think the returns can be really pretty phenomenal – something around 5,000 in the coming 12 months. – Bloomberg
He also enunciated that he has not seen market strategists this pessimistic for a while over the coming year’s forecasts (and strategists are generally optimistic on average). As such, he thinks such pessimism forebodes well for the SPX’s potential returns over the NTM.
Takeaway
With the market cautiously positioned after a sharp recovery for the SPX and DJI from their October lows, we expect a healthy pullback. However, we don’t expect those lows to be decisively broken, critical toward supporting our thesis of a medium-term bull market (higher lows, higher highs).
Hence, we encourage investors sharing similar conviction levels to be buyers on pullbacks. Our assessment suggests that the NDX has the potential for outperformance, despite its relative underperformance in 2022.
Fund managers’ reduction in tech exposure is also constructive for tech to potentially resume its long-term outperformance against the SPX and DJI if tech companies continue to outperform their marked-down earnings projections moving ahead. Hence, it could spur the buy-side to increase tech exposure, spurring more potential gains given their current exposure.
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