I agree with Doug Kass: 'Here's Why I Am More Bullish Than Many'; Value Investors Bet Recent Market Leadership Is Just the Start; Facebook, Netflix, and PayPal Are Value Stocks Now; Trump's social network deal is under grand jury scrutiny; First days in Italy

1) In Friday's e-mail, I discussed the raging debate about inflation and the economy.

So what are the implications of all of this for the markets? The half-dozen or so multibillion-dollar hedge fund managers I've spoken with in the past week are universally bearish and positioned defensively, which I actually view as a positive indicator.

My views more closely align with my friend Doug Kass of Seabreeze Partners, who wrote the below on Thursday...

Pangloss I Am Not – But Here's Why I Am More Bullish Than Many

• Does a mild and brief landing lie ahead?
• Have interest rates peaked?
• Will lower rates lead to a rally in large-cap growth stocks and for the market as a whole?

I am growing increasingly, and incrementally, more bullish on equities, in part based on my expectations of a mild and brief recession and a possible rapid deceleration in the rate of inflation, causing a less hawkish Fed.

I respect the difficulty of a soft landing.

However, some of the following conditions suggest a briefer and more mild economic downturn than is generally expected by the consensus:

• $2 trillion of excess consumer savings.
• A cushion of sizeable unrealized/embedded gains in the nation's housing stock.
• A strong industrial/corporate base that has generally improved their balance sheets by rolling over into inexpensive debt over the last five years, and has maintained high profit margins.
• A still robust and tight labor market, with solid wage increases a highlight of the last several years.
• As noted in this post, some important components of inflation are moderating – the prices of commodities have fallen considerably over the last 2 ½ weeks.
• Interest rates may have peaked.
• Developing signposts that the supply chain disruptions are slowly behind resolved.

Pangloss I Am Not!

The confident optimism of 2021 has morphed into the unsteady fear and uncertainty of 2002.

Investor sentiment is sour and worsening, along with lower prices.

Hedge funds and retail investors have considerably de-risked and de-grossed. Several high-profile and formerly successful hedge funds have effectively folded under the pressure of poor performance and redemptions. This happens at bottoms, not at tops!

Bank of America's (BAC) Bull/Bear Indicator hit zero last week. The last few times this occurred was in August 2002, July 2008, September 2011, September 2015, January 2016, and March 2020. The Pollyanna strategists of late 2021 have been converted to Cassandras in June 2022.

I am not dewy-eyed.

I am mindful of the difficulty in landing soft. At a recent Ira Sohn Conference, my idol Stan Druckenmiller understandably said:

Once inflation is above 5%, it's never been tamed without a recession. If you're predicting a soft landing, you are going against decades of history. Could happen, anything is possible, but odds are stacked against you.

But I do recognize the resilience shown by the consumer and by corporations over history.

I remain struck by the differences in perception and reality between late 2021, when there was a negative optionality of outcomes, compared to today, a possible positive optionality of outcomes...

Today, conditions are quite different – as the potential for the positive optionality of expected outcomes are expanding:

• Stocks are no longer priced to perfection. Valuations have retreated from 23x to 16x. Many good stocks have been rerated by 50% without a material change in fundamentals. 

• Speculation and froth have been rooted out of the markets – the declines in speculative stocks have been as deep as in any cycle that I can remember, and that includes the dot-com era. As examples, Carvana (CVNA) has dropped from $376 to $25, Coinbase (COIN) has declined from $368 to $62, and Robinhood (HOOD) has fallen from $82 to $7. The market is literally littered with an unprecedented accumulation of disasters.
• Even the perma-bulls have materially lowered their S&P price targets. Some, like Ed Yardeni, have entirely thrown in the towel. The Bears' S&P price targets are now 3,000 or lower.
• Today, bears are lionized. The Trojan priestess, Cassandra, has had a renaissance of popularity!
• Interest rates have moved up dramatically and there is plenty of room for rates to retreat from here. Credit spreads have widened considerably.
• Consensus earnings, economic and market expectations are being taken down and have become more realistic.
• Inflationary expectations likely have peaked. Already commodities prices are turning lower. Soon the rate of gain in home prices will rapidly decelerate – and the decline in stock, bond and cryptocurrency prices – and "negative wealth effect" – have become nontrivial headwinds towards reduced demand, likely also contributing to a slowdown in inflation.
• Market positioning has turned conservative as investors have de-grossed and de-risked. As an example, Dan Loeb's Third Point hedge fund was recently only 23% net long, compared to 71% at 2021 year end.
• Volatility is elevated. There is room for the VIX to decline if inflation moderates and we land more softly than the consensus expects.
• The Federal Reserve has already begun to tighten and, given signposts of moderating inflation and slowing GDP, the neutral rate may be lower than is generally expected.
• The Russia/Ukraine conflict continues apace but, hopefully, is closer to ending than starting. And, also hopefully, the end of the lockdown in China could also be closer to being resolved.

Has the Market Overshot to the Downside?

This chart indicates that bad starts to the year often lead to a second-half recovery:

Bottom Line

I am mindful of the challenges of executing a soft economic landing.

Nonetheless, a mild and brief economic downturn remains my base case.

Gazing into the rear-view mirror is not the key to delivering superior investment returns, as markets are forward looking. Consider, for example, how murky conditions were in early 2020 as COVID spread. The market rally from that point in time was spectacular.

For the reasons mentioned in this missive, and others, I am a buyer of equities.

Thank you, Doug!

2) There are some interesting charts in this Wall Street Journal article about how value stocks have outperformed recently: Value Investors Bet Recent Market Leadership Is Just the Start. Excerpt:

Although few corners of the stock market have emerged unscathed in 2022's dizzying sell-off, value shares – traditionally considered those that trade at a low multiple of their book value, or net worth – have held up better than most. By one measure, they are on track to beat shares of fast-growing companies by the widest margin since 2001.

3) Growth stocks have fallen so much that many are appearing in value indexes, as this article from the front page of Friday's Wall Street Journal notes: Facebook, Netflix, and PayPal Are Value Stocks Now. I view this a good indicator that high-quality growth stocks are cheap. Excerpt:

Investors are positioning for a big reshuffling in the stock market Friday.

Index provider FTSE Russell is due to rebalance its stock benchmarks at the close of trading, adding and deleting companies from indexes tied to trillions of dollars of investments.

Among the stocks on the move are former darlings Meta Platforms (META), the parent of Facebook, Netflix (NFLX), and PayPal (PYPL). All three will jump into the Russell 1000 Value Index, and their weights in the Russell 1000 Growth Index will dwindle.

4) Further evidence that, as I've long predicted, regulators are going to block this putrid deal: Trump's social network deal is under grand jury scrutiny.

5) Greetings from Italy!

I flew to Milan on Friday night, arriving mid-day on Saturday. I had a six-hour layover, so I took the train into town and bombed all over the city on Bird and Lime scooters. I saw the Sforzesco Castle, Duomo, Scala opera house, got shut out of seeing The Last Supper (you need to book tickets well in advance), and had a late lunch along the canal in the Navigli district.

Scooters are the best (albeit not the safest!) way to get around as a tourist – cheap, fast, you can drop them anywhere, and you really get a feel for a city that you don't get with a bus, subway, or taxi...

I then took a short flight to Olbia on the Italian island of Sardinia and met Susan. (We flew separately – her through Paris – because she's flying back on Saturday, while I'm going to spend another week in London then Trani in southern Italy.)

Our Backroads trip started yesterday morning when we met up with our friend who invited us, her boyfriend, the two other couples they invited, and the 15 other people on this trip – 23 of us in all.

After driving half an hour to the lovely village of San Pantaleo, we hiked 3.8 miles down to the coast, had lunch on the beach, hiked another 3.6 miles, and then took vans to our hotel where we're staying for two nights.

This is a multi-sport trip, so yesterday was hiking, today is biking and snorkeling, etc.

Here are my Facebook posts (with pictures) from Saturday in Milan and hiking yesterday in Sardinia, and here are some pictures:

Best regards,

Whitney

P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.