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3 Legs of the Stool – Weekly Update Notes (June 19 – June 24, 2022)

Executive Summary

  • 16.3x for forward valuation, and peak to trough decline of 30% this year = top decile decline
  • 2Q22 eps season in 2 weeks: if the stocks/market are flat to up on eps cuts = fully discounted/if down-on eps cuts=more discounting to come (we are in the former)
  • CPI prints are backward looking versus commodities/wages are forward looking and both are trending down
  • Housing 2022 vs 2006: much different in a very good way = manageable price correction

1) MARKET: The market is trading at 16.3x forward earnings versus the 2022 range of 21.8x to 15.3x intraday low last week. The almost 30% peak to trough multiple contraction is one of the larger ones over a 6-month period. The market has been worried about inflation and is now worrying about a recession. Industrial Commodities Price Index peaked in March 2022/Yields may have peaked last week when the 10 year was 3.5% and the Fed Funds Futures were estimating 4+%, but now the 10 year is 3.1% and the Fed Funds Futures are now 3.5% peak/the market made a low of $3650 (15.3x) last week/Fed should be at 300bp for rates by Sept and could be 50bp from peak tightening. All of these are signs that the bottom may have happened, depending on the severity and duration of the slowdown and amount of eps cuts that occur. The 2Q22 reporting season is two weeks away and companies have plenty of cover if they want to reset eps for 2H22: strong $ that impacts international sales/rate rise environment/war/inflation/etc. Our base case is that the slowdown will be mild, and the bulk of the market discounting has happened, but the best tell-tale sign is how the stocks, and the market reacts to eps cuts: if the stocks are flat to up = fully discounted/if the stocks drop further = more discounting needed. Our range remains $4300-$3800 (with the $3600 level as a “V” level that could be retested).

2) INFLATION: The CPI of 8.6% for May is backward looking, while the S&P GSCI Commodity Index, down 10% in 2 weeks, is forward looking/DB Agricultural Fund down 10%, the past 2 months is also forward looking. Fertilizer prices peaked in March 2022 and are highly correlated to future food prices. Wages have been flat for the past 7 months and are facing more headwinds as corporations plan for the next 12-18 months and are tightening expenses by fire/freeze/slowing hiring. Also, with wages at 5.2%, below CPI of 8.6%, this situation usually resolves with CPI dropping further. The copper/gold ratio, a good proxy for the 10-year yield, is at 2% versus the actual 3.1% 10 year, indicating that yields have peaked. Finally, Chairman Powell is showing resolve that he is ready for his “Volker” moment: with urate of 3.6% (3.5% is all time low) and inflation at 8.6% (40 year high) he is “unconditional” in his fight to slay inflation.

3) ECONOMY: Housing 2022 versus 2006: 70% equity versus 60%/FICO scores 766 versus 699/ ARMs facing reset 1.4m versus 10m/prior 5-year average housing starts 1.5m versus 1.95m/mortgage rates 6% versus 6%= a price decline of 10+% est. vs down 30+%. Market sentiment as measured by the Bull Bear Ratio has been below 1.0 (long term good entry point) for 2 months and last week’s reading of .60=March 2020 lows. The past 17 inflation spikes back to 1940, the following 12-month market returns averaged +13%, with +9% if accompanied with a recession, and +17% if no recession. Reminder that 2nd year Presidential market cycles make their bottoms in the Summer before the mid-term elections and rally the 4Q of the year. Thanks again for your partnership with Main and please let us know what we can do to help you and your clients.

Originally published by Main Management on 24 June 2022. 

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