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Contrarian Bullishness

| January 30, 2023

Last week we painted a rather rosy 2023 picture. But we’re also aware how central banks, economic data, and market forces are colliding right now. So, today we want to clarify the situation using more recent data to explain this convergence.

First, keep in mind that markets are future focused. Thus, the decisions and information related to today’s markets are already factored into current prices. Those prices mirror future expectations (not what already occurred).

Also, economies move slow. They’ve been likened to sailing tankers full of cargo. Meanwhile, markets are much faster and more agile. Think of markets like cheetahs. They move fast and pivot quickly.

Two weeks ago, the market sagged due to hawkish comments from Federal Reserve Bank of St. Louis President James Bullard. But at the same time the Fed can't be perceived to be too far out of line with what is happening in the market, specifically how the yield on the 10-year Treasury has fallen about 20% from a peak of 4.23% in October 2022 to 3.39% recently. And since the Fed doesn’t want to fight market rates, it leaked to a favorite media outlet that it expects to raise interest rates 0.25% rather than the 0.50% hikes it has been undertaking. Our uninformed opinion is that the Fed will then hold steady awaiting more inflation data.

Again, economies are slow-moving ships. A loaded tanker takes about 20 minutes to stop, drifting more than five miles in the process. Markets are cheetahs whose quick, regular movements can compound with each passing trading session. What’s interesting is that even the headlines are shifting recently. The financial media now talks about investors positioning for recovery, citing positive equity inflows for the first time in 10 weeks.

This aligns with what we're seeing with “big money” investors and MAPsignals’ trusty Big Money Index (BMI), which is a 25-day moving average of “big money” investor activity. The BMI has risen for most of January, even after a slight pullback about a week ago:

Also, there’s not much cause for concern in stocks and exchange-traded funds (ETFs) because selling is still minimal. As you can see, Jan. 16-19 saw investors continue to find value in small- and mid-cap stocks:

This supports the data we see. The equal-weighted S&P 500, which gives the same proportion to each stock in the S&P 500, has broken out significantly above its 200-day moving average. Smaller stocks are driving performance. Meanwhile the market-weighted S&P 500, which weighs constituent stocks by market capitalization, is struggling to do the same because it values larger companies more than smaller ones.

So, we’re seeing bullish moves in smaller stocks under the surface. It’s reflected in “big money” activity and the performance of the equal-weight S&P 500. Still, fear of a recession looms and it’s causing worry. Our base case has been a potential recession around the third quarter of this year. But from a market standpoint, you never really feel the recession of a company unless there’s a whiff on earnings.

Interestingly, we may be seeing that emerge. Knowing the market is forward-looking, there is a recent narrative that the recession may have been pulled a bit forward this year. That would support the recent underlying buying as the market looks to later in the year.

Recession Now, Recovery Sooner?

There are seemingly negative datapoints supporting an underlying contrarian bullishness. One piece of evidence is the earnings estimate downgrades from most of last year:

These downgrades allowed companies to avoid big earnings whiffs so far. While many talking heads said earnings estimates need to decrease more, one can argue that more than six straight months of downgrades may be enough.

It begs the question – have we already seen the cuts and moved on? Perhaps.

A second piece of negative bullish evidence is in the financial sector. Earnings among large financial firms were a mixed bag. The biggest example was the difference between Goldman Sachs, which dropped 6.4% after earnings, and Morgan Stanley, which rose 5.9% after earnings.

Additionally, JPMorgan Chase CEO Jamie Dimon altered his tune. He was calling for an “economic hurricane” in the past but now thinks any recession will be mild.

Next, we turn to consumer and production data. We know consumers were flush with cash from government stimulus. Spending that cash created a retail boom, increased production, and rising prices. Now we’re seeing a different pattern emerge earlier than expected:

Consumer spending remains strong, but funding has shifted to savings balances and credit. Recent retail sales data shows a contraction of 1.1% in December 2022 as frugality becomes more the norm:

October 2022 expectations called for about $300 billion in excess consumer savings remaining in the second quarter of this year. The estimate is now $75 billion. As a consumer-driven economy, this could pull the “recession” ahead by a quarter or so, again supporting a contrarian market bullishness.

Additionally, recently we saw industrial production decrease by 0.7%, which is another leading recession indicator. The three-month annualized change is down too (analyzing quarterly makes a difference):

From a contrarian perspective, these are all good things. It indicates that we're farther along in the cycle than anticipated, which supports a stronger market, sooner than originally anticpated.

The final datapoint of contrarian bullishness comes from the world of oil. Last year was the year of oil. This year might be too with this profit outlook:

The oil industry’s profits are so big that its trailing 12 months of free cash flow could purchase every major, publicly traded “green” energy company:

With China's reopening, the U.S. replenishing the Strategic Petroleum Reserve, and inventory deficits at historically high levels, we expect energy prices to increase and thus stocks to climb into the second quarter of this year. This will likely eat into consumers’ discretionary spending budgets as they spend more on energy in the first half of this year before relief arrives.

None of this is meant to cause fear.

We searched for reasons why our upbeat outlook seemed to be happening earlier than expected. The leading recessionary indicators discussed in this post may be why (don’t forget the increasing number of layoffs either).

These events are occurring a quarter before they were expected, making it a real possibility that recession is here. Thus, we think it’s possible that bullish recovery could start sooner too.

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The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.