The Simple Case For A Near-Term Stock Bounce

There’s a decent case to be made for a near-term bounce in US equities coming off a very bad month for the S&P and an even worse stretch for the Nasdaq.

Notwithstanding the landmines (e.g., Netflix and Amazon), earnings season is actually going ok, especially considering the circumstances.

The bar was low and on balance, corporate America is in the process of clearing it. More than half of the S&P has reported, and earnings growth is around 9%, better than the 5% consensus expected coming into reporting season (figure below).

Of course, that’s a superficial, naive way to assess the situation. Guidance is what counts, and while every Wall Street bank has a “tracker” that purports to quantify qualitative assessments as delivered on earnings calls, there’s a sense in which common sense might be a better guide in the current macro environment.

Common sense tells us that, 1) China isn’t giving up on “COVID zero,” 2) there’s a war in Europe, 3) real wage growth in America is deeply negative and 4) the Fed seems (more than) willing to sacrifice some growth, and even some jobs, to bring down inflation. The outlook isn’t idyllic.

But, as ever, it’s worth distinguishing between the “big picture” (so to speak) and near-term tactical considerations, and on that latter score, a growing chorus sees scope for a tactical rally once the Fed event risk clears.

It’s hard to imagine Jerome Powell validating or tacitly endorsing the notion of multiple 75bps hike increments on Wednesday. The bar for a hawkish surprise is pretty high, although I’d emphasize that Powell has no choice but to reiterate a steadfast commitment to the inflation fight.

The simple argument for a tactical rebound is just that if you don’t count a reiteration of the Fed’s resolve as a hawkish escalation (and you shouldn’t because, again, they have no choice), then the combination of bombed-out positioning and the return of the corporate bid may argue for upside.

“Equity volatility has coincided with the buyback blackout window [which] limited a key source of demand,” Goldman’s David Kostin said, noting that “by next week, most firms will have exited their blackout windows.”

Headed into earnings season, the bank’s buyback desk said repurchase activity was near record highs in 2022 and Goldman expects 12% growth this year (figure below).

Authorizations were $1.2 trillion in 2021 and recently reached $400 billion YTD. That, Goldman noted, is “22% above the record pace at this time last year.”

Meanwhile, positioning and sentiment can scarcely get worse. Equity flows have turned negative on a four-week rolling basis and recession calls are pervasive.

Goldman’s indicator has plunged (figure below). As the note below the chart reminds you, the gauge is just a rollup of positioning across investor cohorts measured against a 12-month lookback.

The sharp drop in positioning “has exacerbated recent price moves,” Kostin remarked.

If you’re wondering whether very low readings can be a contrarian indicator, the answer is “yes.”

“Extremely light positioning has historically been indicative of a near-term rally,” Kostin went on to say, late last week, when the gauge hit -2.5. “Readings below -2.0 have been consistent with one-month forward returns of +5%, on average.”