Equities are increasingly priced for a soft landing.
You can look at that one of two ways. If you’re an optimist, you could argue efficient, forward-looking markets know best, so the odds of a soft landing must’ve gone up recently.
If you’re a pessimist (and, with apologies, being a pessimist is very often synonymous with being a realist) you might contend that far from being efficient, markets, and particularly equity markets, are too beholden to the vagaries of human emotions to be trusted.
Goldman’s risk appetite indicator has moved up meaningfully, and as the bank’s Peter Oppenheimer and Sharon Bell noted, it’s a function of a “sharp pro-cyclical repricing across assets,” which has pushed the growth component to a two-year high.
“Markets have moved ahead of macro data, and the current gap between PC1 and macro surprises is large, suggesting that a soft landing is being priced,” Oppenheimer and Bell wrote, referencing disconnect in the figure on the right above (the red annotation is mine).
This comes at a time when, at least according to the media narrative, hard landing risks are growing due to, among other things, the persistence of central banks’ hawkish bent and China stimulus disappointment (which was entirely predictable, by the way).
It’s not terribly difficult to make the case that the market is wrong here. PMIs suggest Europe is stagnating again, Germany is plainly struggling, the US labor market is showing some early signs of cracking just as consumers’ savings buffers are poised to finally run out and China hasn’t managed to craft a coherent, whole-of-government plan to revive an economy waylaid by years of pandemic control measures and a sweeping regulatory crackdown in the name of social reform.
There are “ongoing signs of deteriorating growth around the globe,” Nomura’s Charlie McElligott remarked, citing decelerating surveys and a “broad, across-the-board downturn in economic surprises.
The same disconnect between markets and the macro is readily observable in global cyclicals versus defensives which, if you plot relative performance with the global PMI, produces a pretty glaring disparity.
“Despite the most recent softening of survey data, market pricing appears to be consistent with stronger growth moving forward,” Goldman’s Oppenheimer and Bell went on.
As the figure above shows, it’s not just the disconnect that sticks out, but rather the “opposite directions” dynamic illustrated by the red and orange diamonds.
If you ask Goldman,”the absolute upside for equity markets is constrained by both high valuations and the prospects for interest rates to remain higher for longer than the market has been pricing.” Oppenheimer and Bell cited commentary from central bankers and ongoing evidence of weakening activity which, while still concentrated in manufacturing, is moving into services.
On Tuesday, while opening this year’s Sintra conference, Christine Lagarde said that “It is unlikely the [ECB] will be able to state with full confidence that peak rates have been reached in the near future.”
The macro data is confusing. Classic indicators (LEI, yield curve, CRE, etc) are very negative. Other datapoints (estimates, consumer, housing, etc) look tentatively bottom-y. The Covid disruptions are confounding. The Fed’s rate campaign is stuttering, and its actions are increasingly dovish. Inflation makes data harder to interpret.
The bullish case is that rates are not going much higher (after 500, what’s another 50), S&P 500 estimates have troughed (are rising, if you look at rolling N12M), valuations can be rationalized (or ignored), and there’s too much money out there that needs to go somewhere.
The bearish case is well articulated by Wilson et al.
Suppose 2Q earnings and guidance comes in positive, or not-negative. Can investors ignore two consecutive quarters of upside, or not-downside?
I am expecting Q2 to be similar to Q1 in better than terrible fashion, beating estimates nonetheless. I am expecting equities to trend down the next 3-5 weeks, but “positive” earnings to be the wing beneath the bullish wings for 2-3 months thereafter.
Q3 is when I expect the earnings (possibly top-line as well) misses. Finance sausage making (aka financial reporting) has grey areas that allow for some manipulation, not generally in total outcome, but in timing and treatment. Corporates have been squeezing every last drop out of earnings for the past few months, without economic upticks (as H says in the article, data is not upticking) They can only keep up the charade for a few quarters.
Not exactly sure how this impacts the odds for a soft landing- but non-OPEC producers (led by US, Brazil and Guyana) are expected to increase production by 5.1M barrels/day over the next 5years, more than compensating for OPEC’s stated willingness to only increase production by 800,000 barrels/day.
Plus, $35T of wealth held by the 70plus crowd (37M) in the US. As this crowd passes, the wealth will either get spent by the heirs- homes, vacations, eating out, luxury items cars, etc. or invested. Parents who did not spend much of their money and kept money in CD’s have children who will, instead, invest in SPY or spend it.
Yet another part of my bullish thesis. If there is a dip, I think it will be short lived.
my recession indicator is door dash, uber eats and draft kings. I call these convenience and ultimate discretionary stocks. I will be interested to hear what these companies say in their next earnings calls. all three are flying high now. it is hard to see how the economy can be in a downturn when people can spend money on these services. When the economy turns, people will still eat McDonalds and Taco Bell but they will pick it up themselves.
H wrote an article about DG earnings disaster a few weeks back and today was WBA turn. I also see those as some what “convenience” stores. They charge higher prices, but they are more convenient than Walmart. you can get in and out for a few items in DG or Walgreen’s before you can even have walked from your car to the entrance of the Walmart. But now customers can’t afford the convenience any more and are going back to Walmart. So their customers are feeling the pinch but the door dash users are further up the chain.