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Equity market futures were pointing to a lower open until the closely followed (for obvious reasons these days) Employment Cost Index came in a bit softer than expectations (note the yellow line [quarter-on-quarter change]:
"Right now, there’s a bubble in zero days to expiration (0DTE) options. North of 50% of the options traded every day expire within 6 ½ hours of the market open. Now we’re dealing with that, who’s bulling the tape to get S&P 4,000 to print, for instance. The volume of 0DTE call buying is changing market behavior – with a small number of dealers forced to hedge which suppresses volatility. But this dealer hedging works both ways and that’s why you’ve seen these wild moves in markets. You need to be careful and have a process for knowing the trend. When things unwind, they unwind quickly."
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My response to my good friend Sam's comment on yesterday's blog post (he mentioned the Q4 2022 economy and the impressive resilience of the equity market of late):
Here are some key highlights from our latest messaging:
Yesterday:
...like we keep saying with regard to corporate earnings:
"On balance, the LEI and other recession indicators are likely to continue sending a recessionary signal in the coming months. Meanwhile, aggregate earnings forecasts remain too optimistic and have room to be revised lower."Hence, the chart we featured in yesterday's note (LEI/CEI ratio in white, SP500 earnings in orange):
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So, if there's one graph (other than the one for our own index) that illustrates what has us not yet believing this year's rally in equities, it's this one (the Leading Economic Indicator/Coincident Economic Indicator Ratio):
So, while our proprietary index (-33) says recession looms,
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Yesterday's action very much jibed with our near-term thesis for the equity market... I.e., data releases (save for mortgage apps) were resoundingly weak (recessionary even), while Fed speakers -- even the doves -- reiterated that the tightening cycle still has a ways to run: emphasis mine...
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In yesterday's strategy session, Nick and I discussed the prospects for the recent trend in stocks (bullish) to, in reflexive fashion, serve to actually avert the recession we're anticipating this year.
The theory of reflexivity postulates that the stock market is in fact, more often than not, not a predictor of economic expansions and contractions, but rather a significant element amid their causes... I.e., rising stock prices incite animal spirits that incite economic activities that incite yet higher stock prices in what becomes a positive feedback loop... While, conversely, falling stock prices quash animal spirits, which incite a pulling in among consumers, which leads to lower corporate profits, layoffs and, ultimately, recession.
The former is a plausible scenario right here that we should in no way entirely dismiss... Problem this go-round is, of course, the Fed.
The following regarding last week’s commentary from bank CEOs -- per our latest messaging -- jibes to a T with our present view of general conditions:
1/15/2023
Judging by the nearly overwhelming consensus among economists, our 2023 recession thesis has exceptionally high odds of playing out… The timing would be the looming question… The safe assumption would be H2, but we’ll stick with our H1 thesis for now.
The consumer still seems pretty engaged with at least the services sector, although, clearly, producers – per both ISM and JPM PMIs, and the general commentary captured in the NFIB small business survey – are bracing for/anticipating a notable slowdown.
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I sympathize with economist Diane Swonk's take on the current inflation setup.
Emphasis mine...
"Goods prices cooled - even new vehicle prices ticked down. But service sector inflation remains way too hot, which is where labor acute shortages play a larger role in price setting. Important to remember some of the cooling in core inflation is simple math.
"...it’s worth noting that the current level of the services ISM is consistent with an EPS drawdown much more severe than anything currently forecast. Using data since the inception of the services ISM in July 1997, a reading of 49.6 is consistent with an EPS drawdown of more than 36% from peak.
I think it’s safe to say that that sort of outcome is not in
the price of equities."
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If you're interested in gaming the day-to-day movements in markets, you'll need to develop an understanding of the immediate focus of (what presently inspires) short-term traders... You develop that understanding by simply matching headlines and data to the immediate, and near-term, market reaction when they're released... Do this long enough, and consistently (with an open mind), and you'll have a decent understanding of what to expect when, for example, an economic headline comes in hot or cold.
Well, I suppose I should add that one should have a working knowledge of intermarket relationships, macro economics, present political and geopolitical setups and constraints, technical analysis, yada yada -- but, hey, just trying to make a point here!
Thinking out loud (on my keyboard) this morning, it seems clear -- tracking market internals -- that market players, in the aggregate, really want to buy equities right here... So much so that they'll sniff out whatever kernel of bullish evidence amid all the data they can, and buy it with both fists... “Bullish” being anything that hints of cooling inflation and an easing Fed -- in other words, anything suggesting that the economy is weakening... Slowing December wage growth tucked within Friday's labor report would be a prime example...
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Interesting action in the pre-market on this first day of 2023... Bonds are screaming higher (yields lower) as folks are perhaps buying into the consensus recession thesis and want to get ahead of it... The dollar is ramping higher as well, consistent with the short-term technical setup I mentioned in yesterday's video... US stocks are up as well, also per the short-term technical setup we explored yesterday, and, I suspect, a continuation of the bad-economic-setup-is-good-for-stocks (as it quells inflation and calms the Fed) trade.
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