Updated January 9, 2023

The Window is Still Open

After more than two weeks of sideways action, U.S. equities ended the week with a broad-based rally of greater than 2% on the back of mixed economic reports.

The non-farm payrolls report showed slightly more job-creation than expected and a lower unemployment rate—both seemingly bearish for equities in light of how they might affect the Fed’s rate-hiking trajectory—but the average hourly earnings number was lower than expected and both factory orders  and the Institute for Supply Management’s Services PMI were significantly below expectations.

The futures market rallied initially after the jobs report at 8:30 a.m. EST, but gave everything back by the time of the factory orders and PMI reports (10:00 a.m. EST). When those came in well below estimates, the market took off and didn’t really look back.

This week we will get a speech by Jerome Powell on Tuesday, the CPI report on Thursday, and the start of earnings season on Friday (the 13th).

If the market holds steady on Monday, it will be yet another time the market has rallied into a Jerome Powell appearance. Most previous times ended badly for equities.

Will this time be different?

Equities are in the middle of their trading range from the latter half of 2022. When they have been near the bottom of the range, the Fed has talked dovishly; when near the top, the Fed has talked hawkishly.

Being in the middle, it might depend on which side of the bed Powell wakes up on, on Tuesday.

But if the jawboning from Fed members, Bullard and Bostic, from last week are any guide, Powell might go easy on equities, as both made comments that the market took as being dovish.

Moreover, WSJ reporter Nick Timiraos suggested Friday after the jobs report that the easing in average hourly earnings painted a “marginally less worrisome picture for the Fed…than the November report.

On the week, equities were up 1.5%, the dollar was flattish, rates were down big (even before Friday’s econ data), and gold was up 2.5% (helped by a 25 basis-point drop in real rates on Friday).

This action across asset classes is compatible with the investor positioning we have mentioned the last several weeks—namely, the ‘Smart Money’ being positioned for a soft landing.

Institutions and speculators, in their respective domains, are long assets that represent growth (e.g., equities, commodities) and are positioned in currencies and bonds in such a way (i.e., short the dollar, long the euro, long the Eurodollar, short the yen) that suggests financial conditions will loosen.

For example, relative sentiment in equities looks set to bump up significantly, from 64% to the mid-to-high 80s this week. Each time equity relative sentiment made similar jumps in 2022 (late-June, mid-October), the market rallied for several weeks.

This “risk-on” positioning does appear to have a shelf-life, however. Without renewed buying interest, the positioning in both the euro and Eurodollar will turn bearish in 3-4 weeks. Typically, risk assets struggle when relative sentiment in both of those assets is bearish.

But for the time being, conditions are still favorable for risk assets. Will the equity market make hay while the sun shines?

To do so, it will have to navigate Powell, CPI, and earnings season.

One force that may help propel equities higher is the intensity of the recent selloff in mega-cap technology stocks. If those stocks can muster a bounce into their earnings reports later in the month, that might be a near-term tailwind for equities.

Indeed, regarding tech, The Market Ear says (emphasis ours): “Friday’s bounce was violent and caught many by surprise. Imagine this is a short term ‘quadruple bottom’ in NASDAQ? Things could get ‘dynamic’ to the upside, especially as everybody sees this market moving lower over the coming months…”

In the same vein, Goldman Sachs reported some of the biggest retail outflows from technology stocks on record this past week.

The market likes nothing more than to scare retail traders out of their positions at bottoms and FOMO them in at the market tops.

We might be witnessing yet another iteration of this age-old dance in the mega-cap tech space right now.

If so, we may see the S&P 500 make another push for the 4000 – 4100 area to repair some of the technical damage done after the mid-December CPI report and FOMC meeting.

Longer-term, U.S. equities are priced to return about 3.9% annualized over the next decade. That compares unfavorably to most other assets. Non-U.S. stocks are priced to return 6% - 8% per annum; the 10-year Treasury note is offering 3.57% guaranteed; the 2-year Treasury note is offering 4.26%, etc.

And in a world where the Fed will eventually have to lower rates (due to the U.S. government fiscal position), gold and commodities are likely to annualize well north of 4% themselves over the next decade.

Thus, while near-term positioning and sentiment may be favorable for U.S. equities, the longer-term picture is still not attractive.

Consequently, should the market rally here in the near-term, it may represent a great opportunity to reduce U.S. equity exposure if one hasn’t already done so. 

At Allio, our portfolios are tilted away from U.S. equities and towards asset classes we believe have better prospects given the secular market environment we are in. Some of the asset classes we favor during this long-term cycle include non-U.S. equities, commodities, energy stocks, and gold.

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