Inflation in focus, Q1 season begins

As expected, the market ran out of steam last week, and consolidation occurred near previous levels. Despite the slight pullback, SPY still looks extended from a Sigma Score perspective (the normalized deviation from key moving averages). Technically, support sits at $403, and near term resistance is placed at $417, coinciding with the upper trend-line and the February peak.

We expect no major price action up to Wednesday, when all eyes will be on the March inflation rate (expected to come in at 5.2%). Core inflation will prove more influential, as the measure excludes volatile food and energy prices from the calculation - this is expected to show a 5.6% increase in March, marking the first time Core inflation will be higher than headline inflation in the current cycle.

Q1 Earnings Season will also come into the spotlight on Friday, when major banks start reporting results.

SPY Analysis

The bond market is looking to have its breakout this week as well, with TLT managing to establish itself above previous resistance (now turned support). Long term treasuries are now trading above the 200-Day Moving Average (by the largest percent in 200 trading days), while simultaneously holding the S2 level. $106 is now key support for TLT, which is also expected to be influenced heavily by Wednesday’s inflation report.

Q1 Earnings Outlook

For Q1 2023, the estimated earnings decline for the S&P 500 is -6.6%, as reported by FactSet. Analysts have lowered EPS estimates more than average, to compensate for the banking crisis and possible recession risks. This sets companies up nicely for a game of “millenial soccer”, where the bar is low and everybody gets a participation trophy. In this case, we expect headlines to be largely positive in the next couple of weeks, as companies “beat” these lowered estimates.

During the first quarter, analysts lowered EPS estimates for the quarter by a larger margin than average. The Q1 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for Q1 for all the companies in the index) decreased by 6.3% (to $50.75 from $54.13) from December 31 to March 30. - FactSet

From an EPS perspective, we are entering the Q1 reporting season with earnings still tracking above-trend. We would like to see these decline to the trend’s level in order to be more confident in a bullish thesis. EPS could still take an ugly nose-dive later in the year in the event of a recession. We conclude that forward guidance will be key in respect to the way the market reacts to the earnings calls.

Revenue growth has seen a notable slowdown since the 2021 peak. As it stands right now, numbers still look healthy, but comparisons are getting tougher and tougher. We expect to see even more of a slowdown after the season is complete. So do the Street’s analysts:

Looking ahead, analysts expect earnings declines for the first half of 2023, but earnings growth for the second half of 2023. For Q1 2023 and Q2 2023, analysts are projecting earnings declines of -6.6% and -4.4%, respectively. For Q3 2023 and Q4 2023, analysts are projecting earnings growth of 2.3% and 9.3%, respectively. For all of CY 2023, analysts predict earnings growth of 1.5%. - FactSet

The key to any kind of bullish thesis this year hangs on two major points: an earnings recovery post the anticipated slump in the first half of the year, and (of course) the Fed Pivot. Speaking of which, the market and mr. Powell are increasingly at odds. The latest data derived from Fed Fund futures have now pushed the expected pivot date to 20 September (from July, previously), with cumulative odds of 53.3% of a reduction in rates.

Takeaway

For the moment, there is no immediate action to take in portfolios. We are monitoring levels for equities and treasuries for support levels to hold. The only real concern would be a spike in inflation that would pressure short term interest rates higher. That outcome could spook riskier tech stocks as well, which have out-performed recently. However, until we get a better insight into the latest inflation numbers, it’s a wait and see approach.