The Factory Daily Letter
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The bullish consensus scenario of the beginning of the year has petered out
But has the worst-case now been priced?
In our last consensus update, we showed how leading market strategists were keeping their year-end S&P500 targets at around 5,000 despite the fact that economists had already started to lower their growth expectations and raise their inflation expectations. Growth forecasts were suffering because inflationary pressures were expected to remain high in the near term largely due to the persistent bottlenecks in global manufacturing supply chains and higher rents. Today we look at how the consensus forecasts have continued to deteriorate and how equity strategists have now adjusted their year-end views and targets for US equities. It is also an opportunity also for us to update our readers on our own scenarios.
Storm clouds gathering? Business and government leaders at Davos have been warning of a darkening economic outlook
While the likelihood of recession within the year remains relatively low for the time being, over recent days there has been much coverage of a succession of speeches by and interviews with leading global personalities visiting the World Economic Forum gathering in Davos, and they have been taking a markedly more cautious tone. The message continues to orbit around the risk of global recession due to the more persistent nature of higher inflation which has both undermined consumer confidence and encouraged a faster and steeper shift in monetary policy than was initially anticipated, while the war in Ukraine and associated pressure on energy and food prices together with the knock-on global effects on protracted Covid lockdowns in China have also been weighing on the global outlook.
These concerns were well summed up by German Vice-Chancellor Robert Habeck, who said "We have at least four crises, which are interwoven", including high inflation, an energy crisis, food poverty and a climate crisis. “If none of these problems are solved, I am really afraid that we are running into a global recession with a tremendous effect on global stability”.
Last month, the IMF cut its global growth outlook for the second time this year, citing the war in Ukraine and pointing to inflation as a clear and present danger for many countries. IMF Managing Director Kristalina Georgieva, speaking in Davos on Monday, said the war, tighter financial conditions and food price shocks in particular have clearly darkened the outlook since last month, although she does not expect a recession yet.
The chart below illustrates how the consensus probability of recession has doubled since the start of the year:
According to the latest consensus economic forecasts, the US will not decouple from Europe (as previously expected)
The tables below show the evolution of US and EU (growth) GDP and inflation (CPI) since 2015 together with the consensus expectations of economists surveyed by Bloomberg for 2022, 2023 and 2024. While the prevailing narrative is that the ongoing war in Ukraine will have a major impact on the Eurozone, current expectations suggest that GDP in Europe will nonetheless be roughly the same as that in the US by the end of the year (and that by 2023 it could be even higher), while as far as inflation is concerned, CPI is also expected to remain higher in the US than in Europe:
The consensus outlook on US GDP has been falling
Inflation pressures were already considered persistent at the beginning of the year due to rising demand associated with the reopening of global economies and supply chains disrupted by bottlenecks.
Since then, war in Ukraine has exacerbated inflation pressures further, the price of energy and other commodities such as agricultural and industrial products have been rising dramatically, raising concerns about the negative impact this could have on economic growth - and the associated risk of stagflation.
While in our last consensus update the Street was attributing less stagflation to the US than Europe (given the latter's proximity to the region and dependence on Russia), US GDP forecasts have now been falling closer into line with expectations for European growth.
As illustrated in the chart below the downward revisions to U.S. GDP forecasts are most pronounced in relation to 2022 forecasts - the median has fallen steadily from a “high” of 4.3% in September 2021 to 3.9% January – and it is currently at 2.7 percent:
...and inflation is in uncharted territory
While the downward pressure on U.S. GDP has been gaining traction, inflation expectations have continued to rise.
At the end of last year, the consensus inflation forecast for 2022 was already well above the Fed's tolerance level at 3.75%. Since then, policymakers have consistently raised their expectations for 2022 - to 7.1%.
Despite the fact that inflation expectations have also been rising for 2023 and 2024, they still suggest that we are closing in on “peak” inflation and the baseline scenario for the Street remains one of normalization as the more idiosyncratic inflationary factors (such as those directly associated with base-effects / reopening and the war in Ukraine) pass through:
What about US yields and the Fed’s rate hike trajectory?
According to the median of economists' expectations surveyed by Bloomberg, U.S. 2- and 10-year rates are expected to top out slightly above 3% before slowing slightly in 2024. As for the Fed funds effective rate, it is currently expected to continue to rise to above 3% in 2024:
So what are the sell-side analysts saying?
The market is currently losing one of its major supports as the majority of analysts have recently started revising down their price forecasts. Over the past 50 sessions, the number of price target upgrades vs downgrades has fallen to an average of -17.3%. And the pace of downgrades has been accelerating. Last Friday, the number of companies with lower target prices topped 162, the highest level since March 2020:
This is at odds with EPS revisions which have been enjoying net positive upgrades following the 1Q earnings season. But the magnitude of these analyst EPS upgrades has been lower than recent seasons and (and have left 2023 untouched). Nevertheless, net positive EPS revisions, albeit decelerating, are still positive for both 2022 and 2023.
The average bottom-up EPS estimate for the S&P500 is up 2.6%, rising from $223.4 to $229.2:
2022 so far remains exceptional in terms of EPS revisions. The rising trend has been uninterrupted over the past year, going against the historical pattern which usually features downward revisions through the reporting year:
So analysts have been sending conflicting messages, apparently uncomfortable with the technical outlook (downgrading their price targets) but content with the fundamentals (EPS upgrades still positive).
The chart below displays the number of consecutive days when analysts have cut their price targets while keeping a positive stance on fundamentals. Over the past 10 years, this kind of behaviour pattern appears to have typically coincided with a market trough. While clearly the backdrop / context varies and the sample of past instances is small, a crude study shows that the market has always managed to rebound following such instances - by 15% on average after 6 months:
Strategists haven’t (yet) capitulated
While analysts take a bottom-up approach to forecasting the direction of earnings for individual listed companies, strategists tend to take a top-down approach, looking at various macroeconomic factors to arrive at a fair value estimate on an index or a sector. So while analysts have been busy adjusting their target prices, strategists have for the most part maintained their bullish stance on US equities this year. Over the past 10 days, the S&P500 has traded at a 17.3% discount to the average strategist’s year-end target:
Despite the fact that the S&P500 has been suffering one of its worst first halves of a year in terms of performance, strategists are still not showing signs of panic. The median analyst target price on the S&P500 has fallen slightly since the beginning of the year (from 5,000 to 4,800) while also worth noting is that the most pessimistic forecast (3,900), is close to the current level of the index, a circumstance that suggests that even the worst-case scenario may now be priced in:
What might the consensus look like on the S&P500?
From a technical perspective, the trend has continued to deteriorate since the index broke its 200-day moving average (which is often an indicator of the long-term trend). It also appears to be forming a bearish head-and-shoulders pattern which is a typical trend reversal pattern.
Our initial technical scenario (that was one of minimal consolidation) has been invalidated while the weakness evident across other indices such as the Nasdaq 100 and Russell 2000, which are already in bear markets, could considered leading indicators on the S&P500.
However, it remains our view that the prospect of a relief rally persists and that it is too early to capitulate. In the short term, extremely oversold breadth indicators (being the percentage of stocks above their 200-day SMAs) and the 7-week losing streak the market has recently suffered are both arguments that support the prospect of a relief rally in the coming weeks. A move back towards the upper band of the downtrend channel that started in January would be consistent with a 10-15% rise depending on the sector.
As mentioned above, the current consensus for the S&P500 this year is sitting at around 4,900. If we consider the correction phase to be over and the index to be entering the last bullish wave of the sequence, then the classic projection of the 61.8% Fibonacci extension of the wave (3) began in July 2020 – taking us very close to the current consensus at 4,950:
The ‘reflation’ sectors remain Street favourites
In the charts below you can see to which S&P500 sectors the highest percentage of sell-side analysts assign buy/sell recommendations.
The reflation sectors such as industrials, materials, and energy are among the Street favourites with more than 65% awarding buy ratings. Interestingly such are indeed the sectors that are among the best performers year to date. The discretionary sector, the worst performer this year (-30.3%) has the lowest percentage of buy recommendations:
On the other hand, the most contrarian sectors are staples and utilities (two sectors that have historically been negatively correlated to rising interest rates).
Unsurprisingly, the three worst-performing sectors so far this year are those that are now sitting the furthest distance from their average price targets. It should also be pointed out that the energy sector, with a year-to-date performance of 52% remains 8.3% below the average target price:
In the table below we present the 20 best analyst picks among the S&P500 stocks on account of their enjoying 100% buy ratings and a strong consensus recommendation score. It must be noted that most of them are offering attractive expected upside potential:
A desire to be contrarian? Here are the stocks least liked by the Street
On the other hand, we present below a screening of those names that are currently the 20 most contrarian according to percentage of sell recommendations vs total, and an average recommendation ratio (ANR) below 4. Moreover, most of them have limited upside potential:
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