Can you buy Junior too many presents?

Here’s a conversation starter for the Thanksgiving table: Sentiment is bearish. Positioning, too. The put/call ratio is near a record high—typically put volumes build over call volumes in weak markets, not when the tape is firm. Should we buy into this Wall of Worry? “What should we buy’’ is the most common question I’ve received in recent weeks. Too many stimulus dollars. But wait! On the policy front, the Fed is committed to more rate hikes, and the amount of global central bank tightening is approaching all-time highs. On the macro front, outside of the consumer (more below), the data is deteriorating. Bodes poorly for future earnings or valuations (more below). Yet the risk-on rally continues. Flows into high-yield bond ETFs are well into the 99th percentile over the last month. Year-to-date equity inflows are approaching $400 billion, good for the second best historically (behind 2021). There are now more stocks in the S&P 500 above their respective 200-day moving average (56%) than in mid-August (51%), even though the S&P is trading some 350 points lower today vs. then. The difference, Strategas Research says, speaks to the improvement in “the average stock” rather than any leadership from “the top of the market.” Tech again is being challenged and crypto will be happy if it can survive this brutal period. “But what should we buy!”

Santa will eventually vacation at the beach, and it will be 2023. Many think the Fed by next spring will be forced to choose between accepting inflation that plateaus around 4% or throwing the economy into a serious recession. The biggest structural inflation components, wages and rents, don’t appear to be moderating fast enough to get prices anywhere near its preferred 2% target. June marked the first time in the past six periods of high inflation (dating to 1969) that inflation peaked (if it has) during an economic expansion. All other peaks came during recessions. Moreover, the yield curve “un-inverted” almost a year prior to the inflation peak in those five past cycles, and rapidly steepened afterward. It did just the opposite this year. The 3-month/10-year Treasury curve currently is inverted by roughly 50 basis points, even as Q4 GDP growth is on track to be the strongest since last year! All this suggests a tighter-for-longer Fed. Consensus is a mild recession, akin to 1990’s, among the weakest of the post-war era. But the absence of a Fed pause or pivot could surprise a market where the notion of “peak yields” is pervasive. Combined with an economic slowdown, particularly a hard landing, this could be problematic for earnings and valuations. Whenever Conference Board CEO confidence collapses (it’s currently at a record low), year-over-year (y/y) earnings per share (EPS) typically has followed. A growing number of investment firms see potential 2023 S&P EPS of $200 or lower next year. Morgan Stanley’s chief U.S. equity strategist’s number is $195. At a 15 P/E, that would represent 2,925 on the S&P. Humbug!

Because now, like a kid in a toy store, we still have too many stimulus dollars to invest. Thanksgiving week historically is bullish. Cyclicals are surging (they’re only lagging defensives by 7%—typical underperformance is 22% peak to trough in recessions), breadth is expanding and equity correlations are at rare highs. Double bottoms atop long-term support marked every major market low for 13 years, and the market is in the strongest seasonal period of the year. From a macro perspective, a weaker dollar, tighter corporate credit spreads and the equity rally hardly scream an impending slowdown in activity. If tighter monetary policy is not keeping financial conditions tight, then is policy really tightening, Renaissance Macro wonders. The descending 200-day moving average is likely resistance. That would allow the Santa Claus rally to continue until 4,120. Then, maybe a snapback. Much depends on the November’s CPI report on Dec. 13, followed the next day by the decisions—and forecasts—of Fed policymakers at the end of their two-day meeting. For now, enjoy the holidays. Fundstrat shares that 88% of Americans eat turkey on Thanksgiving, a figure it says is lower than the number who expect a recession next year. Will I see you at the toy store on Friday? Better not get junior too many presents. He’s likely to just play with the boxes.

Positives

• Consumers in the holiday spirit They still have jobs and an estimated $1.1 trillion of excess savings and are boosting purchasing power with credit cards—September revolving credit card debt reached a record $1.2 trillion. Redbook sales rose 7.5% y/y in the past week, mortgage purchase applications increased a second straight week and October new home sales surprised, up 7.5% vs. September. Michigan’s final read on November sentiment also was revised significantly higher on improving current conditions and expectations and easing inflation expectations for the year ahead.
• The Fed would like this While the Employment Cost Index and Atlanta Fed research show wages still running well above the 3-3.5% pace consistent with the Fed’s 2% target, there’s broad softening below the surface. The share of sectors with wage growth above 4.5% has plunged from almost 80% last year to 35%, Evercore ISI says. Anecdotal signs of weakening range from accelerating layoffs (the latest weekly jobless claims hit a 3-month high) to seasonal Target seasonal workers getting raffle tickets for a chance to win prizes instead of holiday bonuses.
• Maybe manufacturing still has some mo … Led by transportation equipment and military aircraft, October durable goods orders surprised, rising the most in four months. Ex-transportation, new orders climbed 0.5%, with increases capital goods, machinery and computer-related goods leading the way. The regional Richmond Fed manufacturing index also surprised on increases in new orders, but it remained overall in contraction territory.

Negatives

• … maybe not The initial S&P Global PMI for November manufacturing unexpectedly fell into contraction territory for the first time since the pandemic hit in 2020. A renewed decline in output and a sharper drop-off in new orders more than offset the first improvement in supplier performance since October 2019. On the plus side, input and output price inflation eased and business confidence improved.
• U.K., the land of misfit toys Its housing finance structure of largely short- and floating-rate loans means monetary tightening will produce a huge income shock next year to around 4 million households—about 15% of the total. This comes on top of spiraling energy and food prices due to the Ukraine war. A Bloomberg survey of economists puts recession odds there at 90%, with the Bank of England warning Brits face the longest downturn since records began.
• A black swan in our midst? The Institutional Strategist is waiting for the other shoe to drop in the FTX saga. For an asset class to plunge more than $2 trillion in a short period with very little effect on the financial ecosystem indicates that 1) major parts of the system were not involved in a large way, 2) the public has not been affected as much as expected 3) both statements are true or 4) the markets are missing something.

What else

A black swan in our midst That’s how Deutsche Bank views the highly leveraged loan market as a tail risk. It notes half of U.S. junk-rated debt is floating rate, a record high. A highly elevated 40% of European junk-rate debt also is floating rate. If there’s a recession and margins compress, it expects there will be pain—and defaults.

Too early to talk 2024? The Economist suggests Biden’s low approval rating means he’ll likely draw a primary challenge, and historically incumbent presidents who face serious primary threats often fail to win reelection. Of the five sitting post-war era presidents facing challengers, all either bowed out (Harry Truman, Lyndon Johnson) or went on to lose the general election (Gerald Ford, Jimmy Carter and George H.W. Bush).

A conversation starter if you’re relegated to the uncool Thanksgiving dinner table It’s estimated that the amount of waste from Thanksgiving generates the same carbon footprint as nearly 1 million cars driving from L.A. to Florida and enough water to supply New York City for 100 days.

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