EZM - The Week On Wall Street - Uncertainty And Confusion

Summary

• The current backdrop is also saddled with regulations. Add in rising interest rates, and that makes for a difficult investment scene.
• The NFIB small business report confirms that and sums it up nicely. This is a bad economy.
• The "technical" view of the market presents an uncertain and confusing picture. That could be about to change.
• Corporate earnings take center stage and that is the next market catalyst.

“Personal finance is only 20% head knowledge. It’s 80% behavior!” – Dave Ramsey

My 2023 Outlook offered plenty of insight into the issues that are going to affect how investors navigate the upcoming year.

• Economic and Market cycles
• The Fed and the Yield curve
• Valuations
• Inflation and Credit Markets
• Housing and Employment
• The Political Scene
• The Dollar and International markets
• Commodities
• Sentiment and Seasonality

I capped off those installments by publishing my "Favorites" for the upcoming year. Overall it was a challenging endeavor to try and put the macro pieces together with so much uncertainty. Laboring in an investment environment that is saddled with regulations, pro-tax and anti-business backdrop with interest rates rising makes for a difficult assignment.

As we enter Q1, we’re likely to see some delayed effects in the economy from the high inflation and Fed tightening due to a combination of factors. The unprecedented fiscal and monetary stimulus that preceded them, a lower labor force participation rate than in the pre-COVID days, and consumers tapping into savings and debt.

Even with monetary stimulus still filtering through the economy, we've seen an additional 1.7 Trillion dollar spending package passed in December. The perpetual extension of the student loan payment pause that is now expected to continue well into next year is yet another example of inflationary stimulus being added to the scene. Despite all of the stimulus packages, consumers are starting to feel what higher inflation in a slowing economy is doing to their spending power. But instead of significantly dragging down spending, the ever-resilient consumer turns to alternative measures to pay for the things they need and want. The latest Federal Reserve November report on consumer credit showed the recent trend of high credit card spending largely continued.

Furthermore:

• Application rates for credit cards reached 27.1% in October, up from 26.5% a year earlier and above the pre-pandemic level of 26.3% in February 2020, per Bloomberg;

• More Americans are tapping into their 401(k)s for financial emergencies, with the percentage of retirement savers pulling money for hardships spiking 24% in the 12 months through Sept. 30, according to Bloomberg;

• “Buy Now Pay Later” online orders increased 13% year over year in November before Thanksgiving and Black Friday and jumped 68% the week of Black Friday, according to Adobe Analytics. This is all evidence of a trend already well in motion — U.S. household debt climbed at the fastest annual pace since 2008 in the third quarter, per the Federal Reserve.

At the same time, the U.S. personal savings rate has also plummeted to the lowest levels since the Financial Crisis days. In aggregate consumer balance sheets are in decent shape there is a contingent that is moving to debt and it’s only a matter of time before servicing that debt starts to become more prohibitive, particularly with credit card interest rates recently hitting all-time highs. The delinquency rate on revolving (credit card) debt is already hooking up and that is another trend likely to continue.

The current narrative seems to be that the economy remains strong and if inflation will just come down, we will be back to the same old environment we were in before COVID. I don't share that view because this is not a low regulatory, pro-business environment. Stimulus measures and inflation fears have pulled forward spending, and if debt levels start to become prohibitive to future spending (especially with rates higher now than they’ve been in years past), it could put a ceiling on both GDP growth and earnings growth. It then becomes a challenging scene where the word "growth" is no longer part of the narrative. If the other shoe drops in the form of a weaker employment scene it will add more pressure on the consumer and that has the potential to cement the recession outlook in place. Worse case, a recession that is not "short and shallow".

So This Economy is Good?

Moreover, it’s not as if all is currently rosy in the economic data. We continue to see poor economic reports week after week. As we keep seeing, the Conference Board’s Index of Leading Economic Indicators continues to drop. It just fell for the eighth straight month and has now declined in nine of the last ten months. Going back to 1959 when the data series starts, there has never been a time when the leading indicators fell like this and we didn’t enter a recession relatively soon afterward in the next couple of years. Now if the employment scene stays resilient, the "no-recession in 23" crowd will be able to celebrate, but that could be a short-lived event. Because it’s the same story with the yield curve, which is about as inverted as it ever gets, another historically reliable recession indicator. So unless "this time is different" the handwriting is already on the wall.

The point is that the economy already has some recessionary momentum behind it and many seem to assume it is “transitory” and will reverse as soon as the Fed does. As we enter Q1, the Fed is still months away from an actual pause, and by their own admission when they do pause, rates will remain elevated for a while. The concern for the remainder of the year will be the shape of the economy, as all of this Fed action is taking place in an already weakened economy. Remember, the Fed's action in '22 will start to hit the economy this year.

The Week On Wall Street

A new week and a clean slate. Equities rallied on Monday, then ran into resistance that continues to cap the upside. It turned out to be a day where an across-the-board rally vanished into the close. The BULLS got a shot of adrenaline and a rally on Tuesday rolled into Wednesday. The action was so strong across the board, it was as if someone had leaked a positive CPI report to the trading desks. The S&P made it three straight days of gains for the week as the index closed up 1.2%. That brought the mini rally to 4+%.

Thursday's action was strong at the start but with more overhead resistance looming it turned into a choppy session with the S&P eking out a 0.34% gain. Despite a three day weekend looming, The BULLS

The Economy

There are many that continue to tell us the economy is strong. The real-world data isn't aligned with their opinion.

The NFIB Small Business Optimism Index declined 2.1 points in December to 89.8, marking the 12th consecutive month below the 49-year average of 98. Owners expecting better business conditions over the next six months worsened by eight points from November to a net negative 51%. Inflation remains the single most important business problem with 32% of owners reporting it as their top problem in operating their business. All but one indicator (current inventories) fell in December. NFIB Chief Economist Bill Dunkelberg;

Overall, small business owners are not optimistic about 2023 as sales and business conditions are expected to deteriorate. Owners are managing several economic uncertainties and persistent inflation and they continue to make business and operational changes to compensate.”

That is about as bad a description of the economy as you will ever see, and does it really matter that this isn't classified as recessionary? It's a bad scene.

Inflation

U.S. headline CPI fell 0.1% in December with the core rate up 0.3%. These follow respective November rates of 0.1% and 0.2%. The 12-month headline clip slid to 6.5% year over year from 7.1% y/y previously and compares to the 40-year high of 9.1% in June. It is the 6th straight month of deceleration. The ex-food and energy component posted a 5.7% y/y versus November's 6.0% y/y.

The good news was on Inflation. It's trending lower and this fits into my '23 outlook. If inflation continues to trend lower, the FED also cools off, and they move to the background. That brings the economy and corporate earnings to the forefront.

That is filtering down to an improvement in sentiment. Consumer sentiment surged 4.9 points to 64.6 in the preliminary January print, stronger than expected, and the highest since April. Easing in inflation pressures has supported the uptick.

While this is an improvement, let's not break out the champagne just yet. The overall sentiment is buried at historical lows.

There is little doubt that just about every economic data point in the last few months has been weak. The steep inversion in the yield curve is aligned with that. The uncertain backdrop is also filled with contradiction, and it's another issue investors have to reckon with.

Despite what we are hearing from the data, CEOs, and Small Business owners, The Atlanta GDPNow forecast sees Q4 GDP at 4.1%. It's your move.

Earnings

The Major banks and a couple of other notable large caps reported on Friday morning. Of the eight major reports, all but two (Citigroup and Wells Fargo) beat EPS forecasts, and only two (Bank of New York and Wells Fargo) reported weaker-than-expected revenues.

From Fundamentalis:

• The forward 4-quarter estimate jumped to $228.38 from last week’s $222.91, which is the expected quarterly bump as we roll into a new forward quarter and drop off the old one. The new 4-quarter period is essentially calendar 2023 estimates.

• The PE ratio on the forward estimate is 17x versus 17.2x last week and 15.5x as of 9/30/22;

• Even with Friday’s rally, the SP 500 earnings yield was 5.86% as of the close Friday, the highest yield since November 4th’s 6%. Remember, the higher the Earnings yield, the more attractively valued the SP 500 is thought to be.

CEOs and management teams might be hard-pressed to stay bullish about their 2023 EPS and revenue prospects considering the Fed, and the slowing economic data, in this business backdrop. So I expect negative commentary might weigh on this earnings period. However, we are going to get some insight as to whether the forecasts from Refinitiv and other research firms are "in-line".

If the S&P stabilizes in the 3800-4100 range it is signaling it believes inflation is going to drop off a cliff. I say that because the typical PE ratio when inflation is ~7% is around 11-12. Of course, other factors come into play but if inflation sticks around at elevated levels, the market can no longer be called "fairly valued" in the current range.

Food for Thought

Here is another data point that keeps me bullish on energy. The latest quota for Chinese crude imports in 2023 was announced at ~800mm barrels. That brings the cumulative 2023 quota issuance to 944mm barrels. A year ago, the equivalent number was 780mm barrels, meaning the latest announcement represents a 21% increase in Chinese crude imports if fully used up.

One of the initial actions that factored into the bullish view on Energy revolved around the negative and anti-business approach that was sure to keep the US supply in check. The Energy Department studies estimated that axing the keystone Pipeline project not only curtailed supply, but the construction period would have supported between 16,149 and 59,468 jobs, with an economic impact of $3.4 billion to $9.6 billion.

However, the Department did acknowledge that the high-end estimate “overstates” jobs because it included jobs outside the United States. Nothing has changed in the war on fossil fuels and until that mindset evaporates (unlikely), supply will be constrained while demand ( C hina) may now start to pick up.

The Daily chart of the S&P 500 ( SPY )

Since the low on December 22nd, it has been a series of higher lows established for the S&P 500. The index now sits above the 20-day, 50-day, and descending 200-day moving average. So we have another close above this important trend line.

The last time that occurred was one month ago on December 13th, and it turned out to be a false move. We'll soon know if the S&P will suffer the same fate this time around. Analysis of the S&P 500 and all of the other indices are covered in detail, along with actionable advice for members of my marketplace service.

Investment Backdrop

Well, here we are stepping into a new year. Unfortunately, the scene hasn’t changed but now it's a new start for the "performance clock". A time when analysts and money managers who are measured on a year-to-year basis get to begin with a new slate. I've often said, just because we turn the page on the calendar it really shouldn’t alter one’s approach to the market but psychologically it often does. I know every market analyst now feels renewed pressure to perform after seeing the year-to-date performance reset back to zero. So we are off and running.

The new "favorites" lists are out, and the forecasts for where the S&P will end the year have been published. Whether you are Bullish or Bearish entering the year the trick is always how are the S&P and other indices going to get to a place that matches your viewpoint. That will not be an easy task in 2023.

From a technical viewpoint, nothing has changed. The year starts out with the major indices in BEAR market trends. It's now become a bifurcated scene that is adding more confusion as the DJIA has been flirting with breaking the downtrend. Meanwhile, the NASDAQ is firmly entrenched in its BEAR market, and the S&P 500 and Russell 2000 small caps are somewhere in between. All that does is further complicate the "technical" backdrop.

Morgan Stanley's Mike Wilson has had the hot hand in calling the short-term swings recently, and kudos to him. Prior to that, he wasn't one of my favorites, in fact, his market calls were "run of the mill" and at times abysmal. Mr. Wilson has been bearish recently and he is now one of the many analysts that are calling for a bigger drawdown for stocks in Q1 with an eventual target of S&P 3000 this year.

Last week I noted;

"If everybody is thinking alike, then somebody isn't thinking." Since that is the case, I'm not going to join them just yet. However, I will need to see some evidence to warrant a more cautiously optimistic view in the near term.

While one or two weeks of positive price action isn't a sign that the BEAR market is dead, there are some green shoots that keep me out of the S&P 3000 club today. Earnings season is here and that might tell us if the green shoots flourish, or get caught in a quick freeze and die.

The 2023 Playbook is all about stocks in Bullish uptrends

If a stock isn't in the Energy, or Healthcare sector, then it is in a BEAR market trend. That leaves investors looking for near-term "long" opportunities with a very limited playing field.

Sectors

Energy

Even as oil prices have plunged from their 2022 highs, Energy stocks have held up impressively well. It was only back in mid-November that the Energy sector ( XLE ) made a new high for the year while oil prices were well off their highs. Despite the outperformance, the sector’s technical picture has deteriorated somewhat. November’s peak was technically a higher high, but it has the potential to become a double-top.

The problem with "double-tops", we never know if that pattern is in effect until after the fact. The longer-term bullish trend lines are positive and it will be important for the group to hold support. So far that has been the case as the ETF tested support on January 4th and bounced higher. In fact, that was good enough to make it four weekly gains in a row. That streak was extended to five this week.

While some are concerned about the near-term weakness, we might be witnessing additional consolidation after a huge run. As I mentioned in my '23 Outlook, I don't foresee the same types of gains as '22 but I don't see this trade as over in '23.

So I am proceeding as if Oil has already made an important near-term low. I take my cues from the longer-term chart. So far, major long-term support has held and boosted crude back up toward $80 before settling in the mid-70s this week. With Oil dropping considerably in the past few months and inflation readings stabilizing, many assume that Oil has put in a major top. I am not so sure and still believe the supply/demand picture could ultimately lead to higher prices.

After a roughly balanced market in 2022, the picture is looking tighter for 2023. Since peaking in 2Q20, global inventories have been drawing as production fails to keep up with global demand. OPEC+ members have continuously failed to meet their production quotas, while restrained production growth by U.S. Shale and the loss of Russian production (and likely more in 2023+) led to a tight and volatile oil market in 2022, with total global inventories drawing slightly for the year.

The biggest risk to that thesis is what I have talked about for months. A global recession that crushes demand. That’s a real risk, but absent that I think the supply constraints, the need to replenish the strategic petroleum reserve, and China's reopening could push Oil back higher just as sentiment on it has bottomed out.

Natural Gas

Nat Gas ( UNG ) has been the leading culprit exacerbating the decline in many commodity ETFs. Looking at the charts at the beginning of the week gave me a sense that UNG might stabilize. As selling continued during the week, the only conclusion that can be made now is Nat Gas has suffered a complete breakdown.

Financials

I mentioned last week that I wanted to see some positive chart action before I got more optimistic about the group. Now I see a sector chart ( XLF ) that is starting to show some promise. The ETF is once again making another attempt to overtake the longer-term trend line that could spawn a new BULL market in Financials. Let's not get too optimistic just yet. The same situation occurred in November and December and both times the ETF failed at resistance. We'll soon know if the third time is the charm.

This is a good start to the new year for the Financials ( XLF ) as they have rallied for four straight weeks. One of the green shoots and another conflicting signal keep us guessing. If the Financials can turn it around it will help the BULL case in the near term.

Commodities

The Commodities Sector ETF ( DBC ) lost 4% in the first week of January as the December weakness continued, then rebounded 3+% last week. Perhaps we've seen an interim bottom put in.

Healthcare

Healthcare ( XLV ) has been in a long-term BULL trend, and this short-term chart is also looking positive. Since the start of the year, XLV has been weaker than the indices. I do see the trading range remaining in place in Q1. At some point in '23, I can envision a breakout to new highs for the sector. The group has the ability to continue as a winner in this BEAR market.

Biotech

The Biotech ( XBI ) continues to bounce around in a tight trading range and is a great candidate for cautious investors to BUY and WRITE (sell) calls against positions for income. At some point, there will be a break either way, and I'm looking for a move to the upside in '23 that could be significant. The first step in that breakout occurred on Thursday.

Gold

I mentioned that Gold ( GLD ) was not part of the commodity debacle last week. The metal continues its run since last November and rallied for the fourth straight week. Don't look now but this precious metal is back in BULL market mode.

Gold has been extremely confusing over the past few years, failing to act as the inflation hedge many feel it is (at least in dollar terms). Having some Gold exposure makes sense for diversification purposes. However, because it doesn't throw off income in a form of a dividend, I'm not inclined to ever have an oversized position.

Now if one wants to have some gold exposure and garner income, then consider buying the Gold ETF ( GLD ) and /or the Gold Miners ETF ( GDX ) and sell upside calls against that position. I added a position in GDX recently. The Daily chart of GDX shows the recent break to the upside, and that move also cleared a long-term resistance level.

Silver

The Silver ETF moved into a BULL trend in December, and this was one time when being early in a trade worked out. The ETF was added in October and the trend is now my friend. The drop below the short-term support line looked ominous on Wednesday, but the immediate reversal on Thursday and Friday keeps the trend positive. I'm looking for a run to ~$24, then a chance to see $27. The ETF is a "buy" on weakness.

Uranium

Uranium ( URA ) is another commodity that has avoided the commodity selloff and has come to life in the last four weeks rallying 11+%. I like the sector as a long-term play on a potential move back to nuclear power generation. Eventually, it is going to become apparent that the ONLY true Green energy alternative that can be a dependable source of power, is Nuclear.

Technology

The NASDAQ has rallied 7.8% since the new BEAR market closing low was set on December 28th. The index has been in more of a sideways pattern since last October and if tested, the BULLS will need that October low to hold.

Semiconductors Sub-Sector

The semiconductor ETF ( SOXX ) looks a lot like the major indices. A situation when the ETF can't break above the 200-day moving average and a series of lower lows in 2022. So here we are once again. Heading back up to the top of the trading range. Similar to what I mentioned about the NASDAQ, this scene leaves us with a slew of possible alternatives.

A situation that has to be dealt with very carefully.

Cryptocurrency

Bitcoin has managed to climb back above its 50-Day MA this week after rallying 1.5%. While the world’s largest crypto has managed to close above its 50-DMA at other points in December, it has not consistently traded above that moving average since before the FTX collapse.

While that move above the 50-DMA is a positive technical development, it is in the face of some of the worst seasonality possible. Bitcoin’s average one-week, one-month, and three-month returns from this time of the year rank in a bottom couple of percent of all periods of the year.

Final Thoughts

If Bear markets don’t scare you out, they will wear you out. There is no symmetry to this investment landscape, and that keeps everyone guessing. I thought that both bulls and bears were going to be equally frustrated as the challenging scene in '22 continues into Q1. Two weeks have gone by and I'm convinced of that. The bears are starting to wonder if this mini-rally is real. I'm also convinced that headlines will continue to rule and we saw that this past week in the form of a CPI report.

The major banks kicked off the Q4 earnings reporting season, which will further impact the course of the market in the next few weeks. It certainly isn't a stretch to say that investor sentiment is going to be swayed one way or the other. We are going to know what group is going to be frustrated the most. It can also give us more clarity on the technical situation that is currently in a state of flux.

That brings up an interesting point about the market. It is important to use the "technical" set up to determine the near term because the market isn't looking at what happened yesterday or what is going on today. So while the global economy is a mess, and the data is coming in at recession-like levels, the stock market is already trying to determine if this poor trend is going to get worse or if it will improve.

Just as I mentioned that we need to see more evidence to get more optimistic in the near term, I also need more evidence to justify joining the S&P 3000 club. Market axioms like the Santa rally and others have been around Wall Street for decades. Some are good, some are at best questionable. The one that has plenty of "credibility" is the December Low indicator. Simply stated, if the prior December lows are breached in January, watch out below. That did indeed occur in 2022 and was one of the indicators I used to start changing my outlook on the markets last February. This year that is S&P 3764, which has been the pivot point that I defined late last year.

Stay tuned.

Postscript

Please allow me to take a moment and remind all of the readers of an important issue. I provide investment advice to clients and members of my marketplace service. Each week I strive to provide an investment backdrop that helps investors make their own decisions. In these types of forums, readers bring a host of situations and variables to the table when visiting these articles. Therefore it is impossible to pinpoint what may be right for each situation.

In different circumstances, I can determine each client’s personal situation/requirements and discuss issues with them when needed. That is impossible for readers of these articles. Therefore I will attempt to help form an opinion without crossing the line into specific advice. Please keep that in mind when forming your investment strategy.

Thanks to all of the readers that contribute to this forum to make these articles a better experience for everyone.

Best of Luck to Everyone!

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