Ever notice the cycling accidents you hear about are either at high speed bombing down some switchback in Europe or when the pack is tight on a flat and someone gives their neighbor the slightest nudge and a huge pile-up results? In market-speak, the pile-up shows you the dangers of crowding in a graphic way, with traders having no room to maneuver because they all occupy the same space, while the over-the-guard rail plunge shows the risks inherent on the backside of the mountain. When was the last time that anyone other than a short-seller got carried out when earnings were accelerating and the market was likewise responding?
VIEW is consistent in our focus on rate of change in the absolute and relative sense when assessing markets. Levels are interesting but we find acceleration or deceleration more impactful on asset prices, so that's where we concentrate. Oh, and the two series in the above chart are highly correlated. As in over .90. The reason we use rate of change instead of a nominal comparison is that a key output for us is a dynamic look at forward near-term return expectations for equities. The above graphic shows the ROC of the S&P 500 alongside the actual and forecast ROC of change in the index earnings (on a trailing 4 qtr basis). Current bottoms-up expectations for the S&P 500 operating earnings look like this:
S&P 500 Operating Earnings Actual/Estimate TTM Y/Y
Q1:21 Q2:21 Q3:21 Q4:21 Q1:22 Q2:22 Q3:22 Q4:22
+8.4% +40.1% +53.7% +66.5% +38.2% +19.9% +13.8% +8.9%
They way we look at the earnings cycle, we passed the peak in earnings rate of change mid-2021 and on a trailing basis in the 4th quarter. Either way, we are on the backside of growth, where it gets smaller and risk assets get more volatile. Going back to 1990, in the quarters when growth peaked, the VIX averaged 17.3. At the trough this was 48% higher at 25.5. Given the negative correlation between earnings and the VIX, this is the mathematical way of saying as things slow they get riskier. The other thing to notice in the above chart are those pesky estimates for 2023. Notice the absolute pancake of a slope in 2023.
S&P 500 TTM Inc(Dec) vs LY EPS
Q1:23 Q2:23 Q3:23 Q4:23
+8.9% +9.8% +9.3% +8.9%
Although history is seldom to repeat, it does end up sort of rhyming. A quick look back at the 2000 peak and then bust in technology stocks offers a little more to our view that the backside is riskier than the front. For the year leading up to the peak in NASDAQ in 2000, the mean weekly price change was +1.5% with a standard deviation of 3.6%. For the year after the peak, the average weekly price change was -1.5% with a standard deviation of 7.0%. That sure looks like twice as volatile to us post the peak in the NASDAQ. Not that we will see the same patter but...the mean price movement in the year prior to the November weekly high in 2021 was +0.6% with a standard deviation of 2.1%. Clearly, we have just few data points post what we THINK may have been the high for this cycle, but the average weekly price change through 1/28/22 was -1.8% with a standard deviation of 3.4%. The point here isn't to get hung up with exact levels, price targets, etc. but to highlight that vol kicks up as we head down, not up, and we think we may have more downside so....consider managing exposures.
What did January Tell Us?
The industrial production, PMI and retail sales numbers told VIEW that these big inputs into the economic cycle all decelerated in December. This fits with our "cycle backside" view. The higher frequency employment figures we also watch likewise didn't improve but look as though they put in a bottom, or top, depending on how you view it. In our chart below, we show the dramatic lift off in US retail sales during 2021 and show just how strong it was. Using our 3 standard deviation rule, this kind of increase is worthy of consideration and it likely doesn't require that much noodling to come to a conclusion. Three stimulus grants and a very favorable change in the timing and amount of the child care credit appears to have found its way into the economy. This sort of bypass of the entire banking system shows the impact direct fiscal stimulus can have. Handing out money gets it spent. VIEW takes the other side of any higher base argument for retail sales and views the slowdown in growth likely to continue for some time from here forward. Especially now that the Build Back Better stimulus plan looks to be at least delayed and smaller or at worst, DOA. The rates market through the 10-2 spread told us the central bank would do well not being too aggressive on tightening lest the signalling value of a flattening curve becomes more pronounced. Oil remains one of the biggest keys to the inflation question and carries a geopolitical bid to it at these levels. It was up strongly in January while copper was off slightly, telling us it is reacting to slowing economic growth. It is should be well known by now that demand for oil and gas is stronger than the environmental wing would like. However, it really is not that much of a surprise for watchers of long-tailed cap ex at the oils. We will write more on that a little later. In short, US equities remain heavily weighted toward the weak link in January, the NASDAQ, and so under-performed developed markets such as Japan and the UK. The dollar was higher against its major pairs in January, this could mean some safe haven bid for the dollar or a reflection of the increased spread on sovereign 10 year debt in the US's favor versus Bunds and Yen.
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