‘Don’t Fight The Fed’ Is Now A Bear’s Mantra

The good news for dip-buyers after the most turbulent period for US equities since the original pandemic drawdown, is that over the past seven decades, corrections have generally been buying opportunities.

Across 33 corrections since 1950, an investor who bought down 10% would’ve enjoyed a median return of 15% over the ensuing 12 months, with a ~76% hit rate. It’s not foolproof. As I put it Sunday morning, sometimes a falling knife is just a falling knife.

But the odds are with you, and generally speaking, your returns will be better versus the baseline over all near-term horizons (figure below).

So, again, that’s the good news.

The bad news is the highest inflation in a generation, a panicky central bank, the prospect of war and something about a deadly plague that refuses to leave us alone.

I’m just kidding. Only not really. All of those things are real. Maybe we angered the gods. Again. As a species, we’re prone to mischief and misbehavior.

Zooming in (and refocusing) the tactical bad news is that a trio of factors monitored by Goldman for evidence of a trough in equities don’t currently suggest the bottom is in.

Take positioning, for example. “Although equity investor length has declined sharply in recent weeks, it still remains elevated versus history,” Goldman said, noting that the bank’s sentiment indicator, which rolls up nine positioning metrics across institutional, foreign and retail investors, usually sits two standard deviations below average when the bottom is in. Right now, it’s just -0.4 (figure on the left, below).

The bank’s Prime data does suggest hedge funds de-risked materially, but even with nets slashed to the lowest since October of 2020, leverage is still “higher than at any time pre-pandemic,” David Kostin said, referencing the figure on the right (above).

He went on to write that, when trying to assess whether there’s a “positive catalyst for equity prices,” Goldman usually looks for “messaging or economic data providing confidence that Fed tightening will not dramatically exceed current market expectations.” I suppose this goes without saying, but we won’t be checking that box for quite some time. Or at least not if the Fed sticks to the current script.

In an interview published over the weekend, Raphael Bostic told FT the Fed could, in fact, hike 50bps. “If the data say things have evolved in a way that a 50bps move is required or appropriate, I’m going to lean into that,” he said, adding that “if moving in successive meetings makes sense, I’ll be comfortable.”

Maybe Bostic is “comfortable” with 50bps and hikes at every meeting. Stocks sure aren’t. Goldman hasn’t yet adopted 50bps as their base case for the March meeting, but Nomura has.

Finally, Goldman said “data reaffirming the outlook for earnings would provide a catalyst to support equity prices.” Unfortunately, we haven’t really checked that box either. Although a little over half of S&P companies who’ve reported thus far beat expectations by more than a standard deviation, Kostin called the outlook for growth “mixed.”

“Of the 44 companies that provided formal FY1 EPS guidance, 23 (52%) have guided above consensus and 21 (48%) have guided below,” he said. Bottom-up consensus for 2022 EPS is unchanged so far.

You can draw your own conclusions. In closing, it’s worth noting that for the first time in… well, in a long, long time, “Don’t fight the Fed” means tilting bearish equities.

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3 thoughts on “‘Don’t Fight The Fed’ Is Now A Bear’s Mantra

  1. The distortions in supply chains, labor markets, and financial markets over the last two years are all rooted in the pandemic. But — and I know this is not the consensus view — the pandemic is coming to an end, rapidly. Exhibit A: the almost-complete reversal in infection rates in NYC (seven-day average down to 6,300 cases from almost 40,000 three weeks ago!). Supply chain and labor market distortions will be with us for a while — too bad there’s no vaccine for those — but not as long as we think, I suspect. As the old blessing/curse reminds us: We live in interesting times.

    1. @mfn, I watch hospital admits as well as new cases. The latter is getting harder to use, in my opinion, because of the increasing use of home rapid tests (results not reported), limited PCR testing capacity, and high positivity (appx 25%). The good news is that hospital and ICU admits appear to have peaked in the US. The worrisome news is that where Omicron BA.2 is present, it is displacing BA.1 and able to re-infect people shortly after they recover from BA.1. In Denmark, which for some reason got the BA.2 surge before other Western countries, hospital admits (and new cases) appeared to peak, then turned upward and are still rising.

      The protective effect of prior infection alone is limited, since the gap in hospitalization and death rates between vaxxed and unvaxxed remains extremely wide despite some 2/3 of unvaxxed cases now in persons with prior infections.

      I think the end of the pandemic – the “practical” end, when it no longer disrupts the economy in a major way – is likely to be when antiviral supply and access is sufficient, maybe in 2H22 in the US. In other words, Covid will still be mutating and infecting, but it will be quickly and effectively treated. I think the other way of reaching the end, which is broad and effective immune protection from current and future variants, will take longer in the US. In countries without access to antivirals and/or vaccines, I think the end will also take longer to arrive.

      China is a different case. Its homegrown vaccines are subpar, it won’t use the Western mRNA vaccines, it hasn’t secured antiviral supply (although it could be working on copies), and I can’t see it abandoning the zero-Covid policy – in part because it is such an effective means of social control (someone might be a dissident? turn his health app red).

    2. While it appears that the pandemic is the cause of our supply chain issues, I would argue that it is just a triggering event. The real cause for this mess is the adherence to “just-in-time” supply management. The whole point of inventory is to cushion producers and distributors against shocks and disruptions in the flow of goods. The point of JIT is supposed to be making more money by minimizing inventory investment. A dollar balance in a firm’s inventory costs 20-25% of the value of the inventory. Cutting inventory close to zero through the effective management of flow in the supply chain provides a big boost to earnings as long as everyone in the chain gets everything right. The truth is that everyone can’t get it right all the time. That’s where inventory comes in. If we don’t have any then the chain breaks where one of the players fails to deliver on time. As we have pushed on this system to milk every last dollar from it we raised the general risk that bad stuff would eventually happen. Now we know. We have two tasks now. First, create some system slack so the channels can refill themselves. I think a big solution here has been to cut the variety in the chain to a basic level — you can’t get this or that size or flavor any more. The other decision we have to make is whether or not to back off JIT and build some inventory or go back to the higher risk approach.

NEWSROOM crewneck & prints