by Bryan Perry
January 31, 2023
After the market’s grand start in January, much remains unanswered amidst the mixed economic data and an earnings reporting period that is also mixed, but the whole package is being bought by investors as the “soft-landing” narrative, helped by the positive vibes over China’s reopening and a sharp decline in Europe’s natural gas prices. Although the inflation data isn’t uniform in trending lower, there is enough of it to convince Wall Street and most everyone else that we’re on the “other side of peak inflation,” or the risk of reinflation, so the Fed can take seriously the option of curbing future rate hikes after this week.
There is now a better than 98% chance of just a quarter-point hike in the Fed Funds rate tomorrow, to 4.50%-4.75%, thanks to a tame Personal Consumption Expenditures (PCE) inflation report last week, showing a 0.3% rise in December, right in line with the consensus. The 4.4% year-over-year read on Core PCE rate continues the decline from November, thanks to a big decline in energy prices.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The market glommed on to this report, but it also took on a more bullish tone when big name companies missed earnings and issued cautious guidance, only to see their share prices bid higher. This price action is the behavior of a market that believes the earnings trough was in the fourth quarter, or the current first quarter, and that improving top- and bottom-line results will emerge in Q2 and pick up speed thereafter.
Stock prices usually rally in anticipation of good news, well before the numbers justify the move higher, sending stock analysts scrambling to adjust their numbers to quantify upgrades and price target revisions.
This is all well and good if the macro picture is indeed improving to the extent that the market thinks it is.
Bidding Cathy Wood’s Ark Innovation Fund ETF (ARKK) up 29.3% year-to-date through last Friday, though it is loaded with sky-high P/E (or no P/E) stocks, is a sign of such hope. But it’s all relative. Shares of ARKK are still down over 58% from the start of 2022 and down 73% from the January 2021 high. That’s hardly something to get excited about when 81% of over $27 billion in invested capital is eviscerated peak to trough in the span of just 24 months. Current assets under management (AUM) are about $7.5 billion, down 73% from $27.7 billion, and investors that put capital in ARKK in late 2000 will have to see the value of this fund more than triple from here to get even.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
I’m picking on the ARKK fund because I find this an interesting “tell” on how fast risk-takers are willing to pile back into the most speculative stocks when so many of Wall Street’s premier chief market strategists are waving red flags of caution and “look out below” signs. Something isn’t right with this picture, and that is why current views and opinions are so diametrically opposed right now. The divisions of views now by very bright and highly respected people are wide and contentious, since there is massive pressure at the professional level not to miss the market’s pivot to a new and sustainable bull market leg.
I chalk a lot of this confusion up to inexperience – younger traders dealing with first-time situations like the pandemic, global supply chain disruptions, and too much money glutting the system – now being drained – plus geopolitical and domestic political brinksmanship, soaring debt levels, a proxy war in Ukraine, and the moral hazard of dealing with all these and other issues that compromise sound thinking in shaping correct policies that are both wise and timely. But here again, the market of late is ignoring any warning signs, forging ahead and creating a sudden sense of FOMO* on cash-rich nervous investors.
(*FOMO = Fear of Missing Out – the flip side of Fear of the Next Crash – something like a FUNK)
Fed policy and moral hazard risk aside, price action reveals much, and truth to be told, this year’s rally has been led by low quality and heavily-shorted stocks. It has also witnessed a strong move into cyclical stocks relative to defensive ones. This cyclical rotation is convincing investors that they are missing the bottom and must reposition their portfolio. And it has been a powerful shift, but bear markets have a long history of luring investors into a new uptrend before they are done. This is a time when investors must trust their stock due diligence and avoid the broader noise. Great stocks can rally even in tough markets.
Any calls for the market to “give back the January gains” are predicated on margin erosion that could lead to a deep slide in S&P 500 earnings by mid-year. When costs are growing faster than sales, profit margins erode, and by the end of the current earnings reporting season, investors will know whether forward sales and earnings will disappoint current consensus expectations. The forward consensus for S&P earnings per share of $230 will come under serious scrutiny in about two weeks when roughly 85% of S&P companies will have reported Q4 2022 numbers. Then we’ll have a better idea about 2023 earnings projections.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The current forward P/E ratio of 17.8 for the S&P is fairly valued on a historical basis and makes a strong case for the S&P to be trading around 4,100 (Friday’s close was 4,070). If the skeptics are right and S&P earnings for 2023 come in around $200 to $210, then a case for a drop to 3,400 to 3,600 is valid. But if the bulls are right and the S&P puts up $230 to $240 in earnings, then there is room for the S&P to rally 4,800 as the P/E could expand to 20x on rising optimism, implying a 25%+ year for the benchmark index.
At the moment, the market favors the latter outcome. So far, so good. But there are multiple cross currents unfolding that will likely determine if the bear market low has already been reached or whether a retest of the lows during the first quarter (or sometime in the second quarter) will mark the ultimate bottom.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
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There is No Totally “Clean, Green” Mining Solution
Income Mail by Bryan Perry
The Market’s Next Direction Depends on the Debatable S&P Earnings Outlook
Growth Mail by Gary Alexander
Gold is Shining Again (After the Fed Killed King Dollar…Again)
Global Mail by Ivan Martchev
The Surreal Correlation Between Junk Bonds and Stocks
Sector Spotlight by Jason Bodner
The News is Depressing – So Try to Ignore It
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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