- Guilty until proven innocent
- Market rally could last through December
- Dollar and bond yields provide rocket fuel
What a week!
The S&P 500 advanced 5.9%, closing out its best week since June.
Friday saw more gains as investors returned to growth stocks in the hopes that interest rate hikes might soon taper off.
More on this shortly… as a better question is how long they stay elevated?
Deeply out-of-favour tech stocks outperformed the Index – up over 10% – the sector’s best performance since April 2020.
Shares of Amazon and Alphabet were up 10% and 11% this week. And the Metacurse surged over 25% on news it’s sacking 13% of its workforce.
Time to get back into big tech?
Not so fast.
This has all the hallmarks of a sucker’s rally.
Guilty until proven innocent.
Look, I hope I am wrong!
I would love nothing more to see the market rip back to 4,800
65% of my portfolio remains long… therefore I stand to gain if prices move higher.
I didn’t sell any positions as we plumbed at the lows.
But the bear market rally this week has taken my portfolio to only being down just 2.5% YTD (given my overweight positions in stocks like Google, Amazon, Microsoft and Apple)
That said, I’m about to make what will most likely be another foolish forecast.
First, I will be very surprised to see this market push much beyond 4200.
That’s about 4-5% higher.
Second, I think we make new lows in 2023.
Yes, the near-term rally may still have a little more juice between now and the end of the year.
Markets are typically strong after mid-terms through to the New Year.
But you won’t hear me say the bottom is in… I think that will be 2023
Let’s explore…
December: Not the Last Fed Hike
New of October’s “softer” CPI had traders doing cartwheels.
Many are now pricing in only 50 bps for December – a welcome relief by the 75 bps the past few months.
But I think it’s arbitrary…
The terminal rate is going to at least 4.75% next year.
Let me stress “at least”….
Whilst these things are near impossible to predict – it could easily push 5.0%.
Remember:
Every time central banks have fought inflation – they raise the terminal rate above that of inflation.
Now we are still a long way from a rate of Fed funds rate of 5.0%…. but it’s possible we see it in 2023.
But with respect to December’s hike – it will come down to the last CPI print we get before the Fed’s next decision
For example, a headline number around 7.50% (what the market currently expects) will probably cement 50 bps.
However, it’s important to bear in mind there are some key inflation components which remain at eye-watering levels. This is what we saw in October:
- Health insurance – up 20.6%
- Utilities – up 20%
- Gasoline – up 17.5%
- Food – up 10.9%; and
- Shelter – up 6.9%
Question is:
How fast are ‘sticker’ inflation components coming down?
Services make up 70% of core inflation and they were up 5.0% YoY.
What pulled inflation lower over October was basically goods (e.g. used cars and things like apparel).
That’s fine… but it’s non-goods we need to see fall.
My thinking is two-fold:
- It’s premature to rule out 7.7% (or above) for November; and
- A number below 7.5% and look for the Fed to pump the breaks
If I am to guess… I lean towards 7.7%+
US Dollar Fuels the Rally
This week the US dollar lost over 2%.
It was the sharpest move lower we have seen in months (similar to bond yields)
Again, all of this was on the (premature) premise the Fed is about to pump the breaks in a meaningful way.
As we know, a lower dollar and yields are rocket fuel for stocks.
Before I update the chart — take a look at this post and chart I published October 18th:
October 18 2022
However, what I was looking for was a near-term pullback (see orange lines) – as it was exceptionally overbought (evidenced by the MACD in the lower window).
Let’s update the weekly chart ~3 weeks later:
Nov 11 2022
Bingo!!
It could not have traded closer to the script.
Along with lower bond yields – this was one of the three things I felt we needed to see for stocks to catch a bid.
The third element was lower earnings revisions for 2023.
They are still coming – with Factset now seeing earnings contraction for Q4.
For what it’s worth, the dollar has room to go lower (e.g. ~7%) — but that’s where I think it finds support.
Here I’m looking for previous resistance (2017 and 2020) to become new support.
In the very near-term (next ~2 months) — a lower USD will be supportive of higher equity prices.
S&P 500: Zone of 4100 as Resistance
Further to my preface, it was a cracking week for equities.
Almost every sector ripped higher… especially long duration assets on the hope of lower rates.
But after a strong rip – we are heading into what I think will be a higher risk zone.
Nov 11 2022
The ellipse labelled “Zone of Resistance” has been pencilled in for several weeks.
In short, I was looking for a “rip” back to the 35-week EMA zone (or around 4100)
And here we are…
But what also stands out to me is what we see with the VIX.
It looks complacent at just 22.5 – given the many risks which have not abated.
Again, just because “used-car prices” fell last month is not reason to be jubilant!
The Fed is going to need a lot more than that.
Now if we see the VIX move down to around 20…that will be your cue for a reversal.
For example, we have seen this twice over the past 12 months (see green arrows)
I think that’s where this current rally potentially runs out of steam.
Putting it All Together
If we see the market trade back to around 4100 to 4200 in the next few weeks – use that to reposition your portfolio.
For example, get rid of the more speculative (e.g., cash flow negative) names (assuming you still have them!)
What’s more, get rid of stocks with weak balance sheets (drowning in debt)
All of these names caught massive bids this week (e.g. the Cathie Wood names) — all on the false assumption the Fed is about to pause or pivot.
The direction for the market over the next few weeks will now turn to the macro (e.g. dollar and bond yields) with earnings behind us.
And in that sense, there’s probably a little more juice.
But I think it’s premature to think the lows are in for the next 12 months.
Maybe for 2022… but unlikely for 2023.
For example, earnings are set to contract 5-10% next year (on the basis we have a recession) – implying the S&P 500 trades closer to 19.5x forward.
That’s not what I consider an attractive risk/reward bet… not with nominal rates above 4.5%