Trading Desk: Concrete Signs Of A Brighter Market

A year ago, the economy was still on life support, with the Fed printing $30 billion a month to keep bond yields low . . . but the market was hurtling from record to record. Now that the situation has reversed, the odds are high that 2023 will end a whole lot better than it started.

Why am I so confident? While there’s always a chance that we’re heading into a multi-year decline reminiscent of 2000-2, the big picture doesn’t line up perfectly. For one thing, if we can avoid a 911 style geopolitical shock, the recovery can start a whole lot faster.

After all, if not for the terror attacks, Wall Street could probably have gotten back to work a lot faster and the really severe losses of 2002 might never have happened. Investors might easily have been spared a year and 25% in paper pain.

As it is, the S&P 500 is where it was in late 2001 where we were in late 2001: down about 20% and roughly a year from its last record peak. Things were actually looking up.

Things look up now. Yes, volatility is elevated, stocks are depressed and interest rates are rising. But for those of us who can liberate even a little cash from the perpetual buy-and-hold mindset, this should be the best entry point in over a decade.

The only question is whether that posture pays off in the coming year. I think it can. And comparisons to where we were last year can be extremely instructive.

Roll Back The Calendar

A year ago, zero interest rates had pushed the S&P 500 to a heady 21.1X projected 2022 earnings. That was reasonable at the time given expectations for 9.4% earnings growth ahead, but the Fed soon threw a heavy wrench into that math.

Half of that growth failed to materialize. In the coming year, Wall Street has given up hope that we’ll see a significant uptick in expansion . . . which makes sense, given how prevalent recession fears have gotten.

(As someone who spends a lot of time out and about in the real economy, I can tell you that any economic downturn on the horizon will be extremely unevenly distributed. Some sectors and states don’t feel the chill at all. If anything, they’re still running too hot for comfort.)

Interest rates are probably close to peaking. At worst, we might see another 0.50 point of tightening in the next six months. After that, the Fed gets more and more likely to relax.

Rates probably go DOWN, one way or another. Either way, the future growth rate looks a lot like what we’ve just lived through . . . and yet stocks are now priced at a reasonable 16.5X projected earnings.

Go back to 2000-2 again. The Fed was a big factor in the dot-com collapse, raising overnight rates to 6.5%. By March 2001, a recession was underway.

But the Fed was paying attention. Remember Alan Greenspan? He started cutting once the economy started to stall. Layoffs tapered off by May and didn’t accelerate again until 911 triggered a secondary shock.

We need inflation to keep cooling before Powell and company can adopt a similar playbook. So far, it seems to be working. And if the economy crumples, inflation is going to melt away with breathtaking speed.

Remember, the problem right now is the job market being too strong. The Fed is desperate to get wage inflation back under control . . . just like it did in 2000-1.

Weigh all the factors and I think the economy looks stronger than it did a year ago. Maybe even too strong! And yet stocks look cheap.

That’s classically a buy signal for investors who have the nerve to look beyond tomorrow’s headlines. And the sell signal is getting weaker and weaker, month by month.

I’ve been watching the VIX or “fear index.” It’s spiked just about every Fed meeting cycle over the past year . . . but then, every time, it’s receded again.

Right here, volatility is a long way down from where it was last January, when the Fed finally got tough on inflation. But the February spike was a little less severe . . . then the May spike receded a little more . . . and then June and October.

At this point, the high end of the cycle is tracking about 10-11% below where it was a year ago. And while the lows aren’t dropping much, there’s a little progress on that front too.

Fear is slowly evaporating. Investors are getting tough. We’re more and more willing to accept a little risk . . . and give our favorite stocks time to prove that they have the right stuff.

There’s still blood on Wall Street, don’t get me wrong. But that’s when you buy. It’s not when you sell.