The Equity View: Pounding the Table

At the beginning of the year, I outlined my rationale for why I expect to see a continued surge in equity markets throughout 2022. The main thesis I had was that the pricing for Fed hikes was extreme, US corporate profitability would allow for continued earnings growth, and that laggard sectors would outperform and be the drivers of continued growth in the equity market. My views, at this stage, are effectively unchanged. 

I also argued for a nuanced sector view - taking it easy on tech but being much more bullish in the financials / commodities / real asset space / value stocks. So far, we have witnessed a rapid rotation from growth into value in 2022, vindicating my sector selection approach, but the pricing for Fed hikes has just grown more and more extreme. 

Tech has underperformed

The famous market adage has been that a rising tide lifts all boats, and this has largely been the reason for stellar index returns over the last decade. In my view, the tide (from growth) may now be ebbing slightly, but fresh currents from value could help to drive returns in the year ahead. Given the drop in indices to start 2022, I am paring my SPX end-year target slightly, to 5400. But this still represents a whopping return from current levels. 

It's been quite a plunge for tech in the last 6 months or so, bit relative returns are still far higher. 

Yields: 

Many market peers have been saying that I was wrong to try and catch a falling knife (although email subscribers will know that I effectively picked the exact bottom of this YTD decline... sign up above), but my conclusion here is that this market, has for the time being bottomed. 

The major tech earnings are out of the way, and the earnings ahead for this week will further help to illustrate where we are going in the months ahead. My personal expectation is that corporate America continues to surprise to the upside. 

Source: Seeking Alpha

The yield curve has steepened dramatically, but again, this plays nicely into my sector views for owning value stocks over the technology names (although, some bargains have started to appear in META, AMZN etc). 

The above chart, I think, is interesting. It shows the QoQ change in 2y rates against the QoQ % return in SPX tech. What is interesting is that the relationship here is relatively inconsistent - sometimes, when we have big declines in short rates, we also see big declines in tech QoQ. This goes against conventional wisdom - lower rates are good for tech, but sometimes, they move in opposite. What is perhaps most clear is that after big drops in yields, tech generally does pretty well a little later. 

The other thing which is interesting to me is that extreme falls in tech are generally precipitated by extremely rapid increases - sure this is a small sample set, but I wouldn't be surprised at all if we saw a repeat of this once more in 2020. I continue to think value is the safer bet, but this is certainly something interesting and worth watching. If yields do start to roll over, the increase for tech could be rapid. 

In terms of hikes, the market is pricing some ridiculous number of hikes from the Fed for the year - see below: 

1Y rates have run riot (1y swap)

This I can almost understand... but the 10y Bund up in positive territory (and more than that, having moved about 100bps of the lows), seems frankly overdone to me. More on this will follow tomorrow in Treasury Tuesday's. I continue to believe the ECB will not be hiking this year. 

My view that the move in yields is done is key to my view that we can see equity outperformance this year - we will have a) no further yield driven declines in tech, and b) have significant enough yields to make value an attractive proposition. Of course, with yields closer to 2%, we should be more cautious in the stocks which are the big dividend payers. 

The whole move higher in yields and increasingly aggressive analyst forecasts has left me pounding the table and screaming at the talking heads on Bloomberg. 

Some now are pricing hikes for every remaining meeting of the year. And yet, we have a Fed which did not immediately taper asset purchases to 0 at the January meeting, choosing to let the program run lower as planned. This is hardly the most hawkish move which could have occurred. 

I continue to predict 2 hikes this year. Once in March, once in June, then inflation will. have cooled enough that the Fed can afford to wait and see and try and exploit any further labour gains - clearly people are heading back to work... look at the January Payrolls number for example!

This is not an economics piece, but much of the data in the US is starting to look a bit more grim and less rosy. Retail sales really stuck out to me in January as a particularly disastrous number (for the December sales), others like industrial production are also starting to show signs of an economy which is not on quite as firm as footing as the analysts might like to think. 

In contrast, the Eurozone seems poised for an explosion as remaining pandemic restrictions are removed, in my view. Further, I would not be surprised to see a full abandonment of the China Covid zero policy before long - this should end any remaining bottlenecks in the region. I'm a little cautious in this aspect, but I am starting to become a big fan of Chinese equities. I'm not outright recommending a buy - as being too early is indistinguishable from being wrong, but it does seem like some of the concerns on China regulation are starting to melt away since there hasn't been much news on this front in a while. There could be a quick 30% gain to Chinese equities if this turns out true and sentiment matures more positive. 

CONCLUSIONS: 

And that really is my wrap. Basically, I like stocks - expect SPX to continue to perform well driven by either tech sell-off which has finished and value outperformance or a rising tide which lifts all boats. Then, I like value, so Europe is a favourite increasingly along with China. 

Sector wise, financials, materials, and industrials are among the favourites but stock picking and specific selection is critical to ensure only the names with the most pricing power are chosen. 

I do not buy the Fed is going to hike 6 or 7 times this year, and instead expect only 2-3 hikes this year. This means that there could in fact be upside as these Fed expectations reprice lower.