The Stock Market: Macro, Fundamentals and Technicals
Where are we heading to?
As promised in my last update, here is my take on the markets.
Let’s start with the Macro.
Inflation
A key driver for the market in 2022 has been the fear of “out of control” inflation, causing the FED to intervene through monetary contraction and raising rates, the worst environment for stocks.
The last CPI reading came at 7.7% YoY inflation, whereas everybody else was predicting anything between 7.9% and 8.2%.
I was hoping to finally see a 7,something % as we as humans over-proportionally give weight to the first number (7). So it feels like we are going down from 8% to 7%.
That’s the reason we keep seeing prices at retail at $9.99 instead of 10$… it just feels cheaper!
Finally, we can see signs of an inflation rollover (blue line below turning down):
This happened even if the price of Oil was not friendly during October, hovering between 85 and 90 USD:
Also, the last data from September of expected inflation 12 months out shows signs of a slowdown, with market participants expecting inflation to be at about 4.75% in a year from now:
So what?
In a nutshell, what spooked the markets is the uncertainty around when inflation would peak and, as a consequence, where the FED would stop raising rates.
If the next CPI readings in December and January will confirm the slowdown of inflation, then the equity markets should respond well.
This is a first very important step… and now I believe the narrative will start to shift towards… recession!
Will the US have a recession? If so, how severe will it be, and for how long?
Other Economic indicators
Let’s look at the total amount of money in the system (M2).
From January 2022 through September 2022 the amount of money in the US economy shrunk by about 6%. This is actually how the FED makes liquidity scarce forcing interest rates to go up:
You can see how the FED started printing money (total M2 Money Stock) when COVID-19 hit the economy and now we are getting back to a more normal level of liquidity. See the trendline (red line) I added to the chart above.
This matters because it helps in answering the question regarding if and how bad the next recession will be.
Very closely related to the amount of money in the system are “credit conditions”. If they get out of control (banks stopping lending, refinancing, etc.), then we may see a stronger recession.
So far there are no signs of over-tightening of credit conditions:
Above is the National Financial Conditions Index and, as you can see the rate of deterioration is decelerating.
If inflation keeps cooling then this indicator should not deteriorate meaningfully from here.
A very important indicator which is very much correlated (inversely) with the stock market performance is the 10 Year treasury yield.
After a strong run-up, as soon as the CPi reading was released it plunged about 10% in 2 days:
This a sign that expected long-term inflation is calming down. A positive for risks assets like equities.
Last, I want to bring your attention to the Global Supply Chain Pressure Index, a gauge for the global supply chain conditions:
As you can see, the supply chain conditions have been improving since January 2022. The effect on prices is yet to be seen which is another good sign for where inflation could go in the coming months.
Lastly, a macro piece of information that matters in pondering recession probabilities is the unemployment rate and GDP.
Here we have a very interesting picture. The unemployment rate is still very low and forecasts for the last quarter of GDP growth in the U.S. are predicting a growing economy (!).
As you can see from the chart above, the unemployment rate has been below 4% for the last 12 months with no signs of strong deterioration.
Now two curious data points that can bring some optimism to the equation.
Did you know that stocks have performed well 100% of the time 1 year after mid-term elections?
On average the SP500 was 14% higher one year after the mid-term elections. 100% of the time!
Best case in 1954 (+33%) and the worst case in 1986 (+2%).
Last is the Santa Claus Rally or more broadly speaking.. the performance of stocks is historically higher in December, have a look:
Starting from 1926, the probability of stocks rising in December is a whopping 78%! And November is the second-best month for stocks at 67%.
Technicals
Here is the weekly chart of the Nasdaq:
As mentioned in a previous update, the index has been hovering around a very dangerous cliff at the bottom of the red box.
The good news is that even with the high number of bad news and sentiment in the market, the Nasdaq managed to avoid collapsing in October / early November.
After the good news from the CPI report, the index popped by about 8% in one week and an incredible +6% last Thursday alone.
Now, the chart suggests that we are still in a downtrend from a mid-term perspective as we are still below the 30 and 40 weeks simple moving averages.
The second box in the chart represents the support area in case of a continuation of the downtrend in the coming weeks.
Fundamentals
Broadly speaking, after a correction of about 30% from the top in the Nasdaq and 25% in the SP500, current valuations are reasonable. That means that the market is not overvalued or undervalued.
It all depends on what economic environment will develop over the next months.
We are in a situation where to see the markets resume an uptrend, we’ll need a stabilization in prices (inflation) and get back to some form of normal economic growth.
If we are heading into a high inflation and high taxes environment, coupled with low growth… then current market valuations would be too high (=stocks would need to compress further).
Otherwise, if we are moving into low inflation, low taxes, and a growing economy, then the current market valuations would be undervalued (stocks can move higher).
Are we going to have a hard landing with a bad / deep recession that last? Or we’ll manage to see some sort of “soft landing” thrugh a mild and short recession?
Conclusion
The odds for a market recovery from here are better now. But things can change fast for the better or the worst.
I expect fund managers to start piling back into the market with caution.
We need further confirmation that inflation keeps declining. The next CPI reading of December 13th will be very important and if it will be good or very good we may see a strong Santa Rally.
On the other hand, the attention will be on the probability of having a recession.
A deep/long recession would reverse the markets to the downside.
My perception is that 2020-2023 will become a case study for future generations as it is a unique case of crises created by a pandemic and an overreaction from governments and central banks.
This overreaction created an asset bubble first (think crypto, house, stock prices, etc) and a bubble burst soon after.
Because of this specific type of crisis, we are in unchartered waters but very likely will get back to some form of more predictable economic growth.
The key is the how we’ll get there.
I think the recession will be mild and short if we manage to see the inflation decelerate consistently over the next 12 months. Why? Simply because the economy is still too strong as a result of the intervention from the FED and government over the past 2 years.
Corporate and household balance sheets are healthy and would take a lot amount of interest rate hikes before making them look bad again.
Because of all the above, I decided to add to the POTS portfolios again (10X FREE POT and 10X SMALL BETS POT), and depending on the developments of the next weeks and months I’ll keep adding to them.
The idea is to avoid predictions, stay flexible and adapt to new information.
Very likely I’ll be adding a few selected new names (stocks) to the POTS.
I’ll let you know as soon as I’ll do it.
Use the comment section for … well comments, questions, suggestions :)
Have a great week ahead!
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Important:
this is not investment advice. Consult a licensed financial advisor before making any investment decision.