This is a marathon

Not easy making sense of this market. Even with this week’s bumpiness, risk assets are off to one of their strongest starts to a year on record. According to Bloomberg and MSCI data, the best since 1987 for the euro Stoxx 600, the best for U.S. investment-grade bonds since 1999, the best for U.S. Treasuries since 1995 and the best for EM equities since 2001. Investors in the U.S. are pouring money into stocks that got crushed last year, a big factor in the year-to-date run, with the “hood ornaments” (Strategas Research’s words) of the Covid bull (Bitcoin, tech ETFs and meme stocks) up the most. Might the massive relative outperformance of high-beta to low-beta stocks just be catch-up after massive year-end tax-loss selling? Perhaps. But it seems like eons ago when the consensus was for the bear market to continue through midyear, with averages falling to new lows before the start of a bull market in the second half. Now, it’s all talk of a soft landing and Goldilocks. With the VIX falling by almost half in Q4, high-yield spreads tightening more than 100 basis points in the same period and forward P/E multiples rerating from 15.1x to 17.4x, it better be Goldilocks! Fundstrat, which notes first-half seasonality in pre-election years tends to be one of the best periods of the 4-year Presidential Cycle, suggests watching the 200-day moving average on the S&P 500 (3,968 at this writing) for clues. A consistent close above it should be bullish. A break below support at 3,860 could argue for retracement to December’s lows.

It’s hard to be a contrarian for very long these days. Consensus seems to change so quickly, Yardeni Group says. I agree. What’s fundamentally different now than just a month ago? Inflation has fallen (more below) but remains roughly triple the Fed’s 2% target. The Fed? Maybe market expectations for its rate trajectory, not its rhetoric. What happened to don’t fight the Fed? Now, China is news. The rapid reopening of the world’s second-largest economy is a big tailwind (and to the opposite, a likely driver of higher oil and gas prices). But it has issues (more below) and, as noted below, other headwinds loom. Manufacturing is weakening. Housing is in a deep slump. Evidence of a consumer who is running out of steam continues to mount. With job growth doubling output, productivity is falling, adding to inflation worries. The best yield-curve recession indicator, the 3-month/10-year Treasury spread, is as inverted as it’s been since 1981! Forward estimates almost certainly haven’t discounted all this, even as earnings are on track for their first down quarter since Q3 2020. Yardeni reports analysts still expect EPS to rise 4% this year. Their average decline in a recession is 24%. Hmm. U.S. stocks remain a big underweight in Bank of America market surveys (arguably, a big contrarian positive, especially with cash at the ready—Lipper says total money market assets are at a historical high). Which way to go? Don’t ask Societe Generale. Its models show a bull market is as probable as a bear market.

So, do you want to play this game? We’re just a year removed from the most extraordinary monetary and fiscal stimulus in our lifetimes—more than $9 trillion—after a once-in-a-century pandemic that literally shut down the global economy. There’s no playbook for this. Applying past performance to these circumstances may well be a fool’s errand. Correlations aren’t likely to mean much, either. The S&P is in no man’s land, stuck between 4,100 resistance and 3,700 support within an ongoing downtrend amid modest signs of momentum. Strategas sees little conviction beyond a bearish bias among some that’s not justified by the tape or conditional factors. The outperformance of cyclical stocks since last July seems inconsistent with a weakening macro backdrop, while the rally in high beta is starting to look overdone. Have you checked out Bitcoin’s sprint year-to-date? Are you a sprinter or a marathoner? In marathons, fast starters don’t always finish and when they do, often lag at the close. Midway leaders don’t always finish, either. It’s all about pacing and perseverance. In volatile markets like this one, it comes to stock picking and picking your spots. I’m just back from Maui, where my youngest daughter just completed her 50th state half marathon! Investing is a marathon and she will be a fine investor.

Positives

• More signs of disinflation Producer prices fell at the headline level and eked out a 0.1% gain at the core level in December, beating forecasts. Year-over-year PPI has now plunged from almost 18% in mid-2022 to 6.2% by the end of the year, on moderating goods and services prices. Apartment rents, a key factor in core CPI and PCE, also continue to fall, which is great news. That leaves the stubbornly tight labor market.
• Brighter global outlook A surge in optimism in China’s PMI survey, a recovery in the developed economies’ manufacturing orders, a turnaround in OECD leading indicators and still-buoyant Manpower survey hiring intentions raised hopes that growth outside of the U.S. may be picking up. Notably, for the first time since Russia invaded Ukraine, Germany’s ZEW sentiment rose sharply, with expectations walloping projections, surging 40 points to almost +17 vs. -15 consensus. U.K. remains the troubled child in Europe. December retail sales there unexpectedly plunged, capping their worst year on record.
• Consumers are spending … U.S. December retail sales may have disappointed (more below) but spending on fun continued to climb. Airlines reported double-digit y/y increases in December traffic, AAA said holiday travel had its third-busiest season since 2000 and Bureau of Economic Analysis data show payment card transactions, retail and food service spending rising 17.1% for the week ending Jan. 3 against a pre-pandemic baseline. Over a 4-week period, card spending was up 14.3%. Goldman Sachs estimates households still have about 65% of their excess Covid-relief savings, and credit card growth grew at a 7.2% annualized rate on a 3-month basis through December.

Negatives

• … just not on a lot of merch December retail sales fell more than expected, with gas stations (largely on lower prices), furniture and non-store retailers hit hard. Department store sales collapsed 6.6%, their third consecutive monthly decline. November sales were revised down, too. Seasonal factors are thought to be partly responsible as they were not adjusted to reflect more front-loading of purchases in October. Still, spending at restaurants and bars unexpectedly slipped—McDonald’s, Wendy’s and Shake Shack have all announced relatively weaker outlooks.
• Manufacturing slump deepens Industrial production fell more than expected in December on broad-based drops in manufacturing. November was revised lower too. Forward-looking ISM indicators suggest further weakening in the coming months, a view reinforced by regional Fed readings for January that showed Philadelphia and New York area activity contracting, the latter to a May 2020 low.
• Housing nearing a bottom? December existing home sales fell for the 11th consecutive month, though beating estimates, and starts fell less than expected on an unusually warm December that aided single-family home builders. Indeed, builder confidence rose in January for the first time in 13 months, as sales, future sales and buyer traffic rose on declining prices and mortgage rates and rising millennial demand. The Mortgage Bankers Association Purchase index also bounced sharply off its year-end 2022 26-year low.

What else

This is not the 2008 China Its reopening is sure to boost other economies, especially in Asia, Latin America and Europe. But nothing along the scale of its impact a dozen years ago. Its stimulus is relatively small and much of the household savings built up during Covid lockdowns are in restricted time deposits. Moreover, its population is declining for the first time in 60 years, a trend that’s expected to accelerate from 1.4 billion now to 800 million by century’s end.

Living in their fears Despite this week’s big Tech layoff announcements, initial jobless claims unexpectedly fell to a 15-week low of 190,000. Bank of America views this as a sign that companies are hanging on to workers in the face of a slowing economy for fear of repeating the mistakes of the Covid lockdown, when workers dismissed in droves never came back.

The next “next big thing” Not even 2-months-old, ChatGPT, the artificial intelligence bot that can write, create art, offer medical advice and do other uniquely human things, has captured the world’s fascination. Its use has become so pervasive so fast that admissions officers, law and medical schools, and others are scrambling to find ways to determine if essays and online tests are “real” or “virtual.”

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