/ May 06 / Weekly Preview
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Monday:
N/A
Tuesday:
N/A
Wednesday:
N/A
Thursday:
Initial Jobless Claims (210K exp.)
Friday:
Michigan Consumer Sentiment (77 exp.)
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Monday:
BioNTech BNTX
Spirit Airlines SAVE
Tyson Foods TSN
Beyond BYON
Coty COTY
Lucid Group LCID
Microchip Technology MCHP
Palantir Technologies PLTR
Simon Property Group SPG
Vertex Pharmaceuticals VRTX
Tuesday:
Walt Disney DIS
Celsius Holdings CELH
Crocs CROX
Duke Energy DUK
Rockwell Automation ROK
Squarespace SQSP
Reddit RDDT
Arista Networks ANET
Cirrus Logic CRUS
Corsair Gaming CRSR
Electronic Arts EA
Lyft LYFT
Occidental Petroleum OXY
Redfin RDFN
Twilio TWLO
Virgin Galactic SPCE
Wednesday:
Affirm AFRM
Starwood Property Trust STWD
Uber Technologies UBER
Arm Holdings ARM
Airbnb ABNB
AMC Entertainment AMC
Beyond Meat BYND
Duolingo DUOL
HubSpot HUBS
Thursday:
Ferrari RACE
Fiverr FVRR
Roblox RBLX
Tapestry TPR
Warner Bros. Discovery WBD
CarGurus CARG
Diodes DIOD
Funko FNKO
Unity Software U
Yelp YELP
Friday:
DigitalOcean DOCN
Testing Resistance after Pivotal Week
Since the beginning of April, we’ve been discussing and preparing for a market correction of the -5% to -10% magnitude. A short term buy signal got triggered on Friday, after a relatively weak jobs report sent stocks and bonds soaring. Last week was also pivotal on the earnings front, with most of the key S&P 500 companies now having already reported. We could surmise that most of the potential bearish catalysts are now behind us - and the markets have proven to be resilient. So is it time to become buyers again? We explore the technical side, as well as the progression of Q1 Earnings Season and what it portends for the rest of the year.
SPY is now at a technical crossroads. The equity benchmark ETF is not overbought, appears to have put in a short term bottom and is looking to challenge immediate resistance at $511 (R1 & 50-DMA). A clear close above this level by the end of the week will spell the end of this correction episode from a technical perspective. The week’s calendar is very light in economic releases and there are not many pivotal earnings reports due. Several global exchanges will be closed for varios holidays. Therefore, we expect trading activity to be more muted and guided by technical signals rather than fundamentals.
The MACD has triggered a short term BUY signal after Friday’s rally. While it wasn’t quite enough to clear 50-DMA resistance on SPY, buying activity was broad based, with both the Russell 2000 and Mid-Caps (MDY) putting in +1% gains. The upside moves were in response to the April employment report. This was weak enough to reduce concerns about a potential rate hike, but not weak enough to invite worries about the state of the labor market.
There was also Apple’s massive $110 billion stock buyback program to support risk sentiment. With many of the previous excesses now corrected to a certain degree, the setup is positive and should allow “bulls” to retest recent highs on the main indices. Transaction volume also got a boost, as dip-buyers stepped in.
Taking a closer look at Friday’s employment numbers, nonfarm payrolls increased a smaller-than-expected 175K, much cooler than the consensus 250K. Average hourly earnings were up a smaller-than-expected 0.2% (the market was expecting 0.3%). The unemployment rate ticked up a higher-than-expected 3.9% (3.8% was penciled in). This report puts at least one rate cut back on the table in 2024, and was well received by the treasury market.
The 10-yr yield declined 17 basis points on the week, to 4.50%. The 2-yr yield declined 19 basis points on the week to 4.81%. TLT bounced off its key Stop-Loss level (now at $88.3) and looks to establish a new “higher low” in the intermediate term. This is bullish for stocks as well.
Jerome Powell’s speech following the conclusion of the latest FOMC meeting provided a more “dovish” than expected message. While Powell did note that progress on inflation has been lackluster, the announcement of the reversal of “Quantitative Tightening” (QT) got the bulls excited:
Beginning in June, the Committee will slow the pace of decline of its securities holdings by reducing the monthly redemption cap on Treasury securities from $60 billion to $25 billion. The Committee will maintain the monthly redemption cap on agency debt and agency mortgage‑backed securities at $35 billion and will reinvest any principal payments in excess of this cap into Treasury securities” - Jerome Powell
The reversal of quantitative tightening means the treasury market now benefits from net buying. This will serve to increase overall market liquidity and means the Treasury will issue $105 billion fewer bonds in Q3. We remind our readers that the Treasury General Account is now reasonably well funded, holding in excess of 900B. With borrowing costs still relatively high, the pressing need for bond issuance will be reduced.
With 80% of S&P 500 companies having already reported earnings, we note the return of higher gross margins, courtesy of our Market Fundamentals instrument, which updates weekly. The compression of margins we’ve seen previously looks to be almost fully reversed, as companies have gained pricing power in the latest quarter. This is also evidence that inflation is having less of an impact on corporate profitability and justifies valuation premiums to a certain extent.
Speaking of which, P/E ratios are still elevated by historical standards. If we use forward looking data, the valuation becomes more palatable, with the 12-month forward P/E ratio for the S&P 500 standing at 19.9. This P/E ratio is above the 5-year average (19.1) and above the 10-year average (17.8).
The valuation implies a 12-month forward EPS target of $257 for index constituents. Given that in 2023 the actual S&P 500 EPS was $192, analysts are projecting a 33% growth to earnings in the year ahead. The bottom-up price target for the S&P 500 now stands at 5754.25 according to street analysts. Our own similar analysis put the price target for SPY at $545 in early March. As new fundamental data comes in, we will also adjust this target in a new report, due for publishing at the end of this month.
There is a case to be made that (optimistically), 12% upside exists for the markets. However, the S&P 500 is by no means the only game in town.
We’ve been eyeing the Russell 2000, who’s constituents (being the most economically sensitive) had the biggest “recession discount” priced in for 2023. As recession odds further get reduced, IWM (the ETF tracking the Russell 2000) has started to trend positively, has bounced off support and has put in a “higher low”. A positive outcome in the economy will most likely mean IWM will outperform SPY in the coming year.
Our Trading Strategy
As potential bearish catalysts get left in the rearview mirror, the bullish case for the economy and the market becomes clearer. With many stocks and sectors not overbought, and sentiment merely “neutral”, this is not a bad time to increase risk exposure.
On a break above current resistance, we will bring our equity risk exposure back to target (and possibly slightly above it).
Of course, there is always the possibility of an unexpected, exogenous event to trip up the markets. Historically, institutional players are reticent about holding long exposures heading into an election, so we often see weakness in September and October. As a consequence, we would expect another period of weakness further down the line in 2024. But that looks increasingly improbable for the next couple of months.
In terms of sectors and factors exposure, the best opportunities right now are in Tech (XLK), Communications (XLC) and small-caps (IWM). But we’ll discuss more about more granular picks in tomorrow’s Portfolio Rebalancing Article.
Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!