The Problem With the Bull Case for 2023

As of Wednesday, the Invesco QQQ Trust Series 1 (QQQ) is up 13.35%… the S&P 500 (SPY) is up 6.53%… and Dow Jones is up 3.63% so far this year.

Aside from the outsized start to the year, the relative performance says it all…

Investors haven’t looked back at the trends of 2022 but are looking forward to a bounce back in 2023.

Last year, momentum strategies profited from a steady downtrend in both stocks and bonds…

But this year, they had their worst performance since the lows back in March 2009. One of those momentum strategies was selling tech and buying value…

In one month, tech has made up what it had lost over the past six months.

Tesla (TSLA) may be a poster child for the voracious rally we have seen, rising 100% from its lows on January 6.

But the prevailing bull case isn’t citing the most concerning data point out there right now – that tech valuations are back to 2021 bubble levels.

But before I call for a big market correction, it’s important to examine what the current bull case actually is…

Making the Bull Case

So where is all this bullishness coming from all of a sudden?

Well, right now, the prevailing bull case is looking at a recently burgeoning credit market, which started to improve in October 2022. And they cite the tendency of stocks to follow…

In addition, some interpretations of economic data show that the much-feared recession either already happened or will never happen at all.

Maybe we can call it the Phantom Recession of 2023.

These folks point to the index of the top 10 U.S. Leading Indicators. This was at its lows back in June with a reading of 10%. That meant only 10% of leading economic indicators were rising at the time, and 90% were not.

Readings that low always coincided with a recession in the past. But now, that reading is at 40, meaning there’s been an improvement. And historically, when it rises from 10 to 40, it coincided with the economy coming out of recession… not heading into one.

Bulls also attack the bears for citing the weakness in the “ISM” – like the ISM Manufacturing Index, which came in with a 46.8 reading recently. That was the lowest level since the height of the pandemic and is a comparable level to past recessions.

The bulls’ counterpoint, of course, is that readings have gotten that low before with no recession. So they say it’s statistically insignificant.

But the biggest reason for optimism that the bulls point to is the most obvious of all… The unemployment rate currently stands strong at 3.4% and has been moving downward.

If you observe periods leading into recessions, that indicator would rise, not fall as it’s doing now.

In fact, there have only been two instances where more than 500K jobs were created in one month… The first was coming out of the Credit Crisis. The second was last Friday. You just don’t see that in recessions.

If the bulls have it right, then that means it’s blue skies up ahead and this market rally is just the beginning… Another classic case of asset prices discounting available information.

But here’s the thing about citing and poring over economic data… All that interpretation, whether for the bull case or against it, is all statistically insignificant.

Reading into any economic data and trying to extrapolate forward can be hazardous to your wealth.

What the Bulls Are Missing

Firstly, we don’t truly have enough data points to make conclusive statistical decisions in either direction. And secondly, every era is different – and there’s nuance.

We have a Fed that has raised rates from zero to 4.58% in record time… and it is well on its way to raising it above 5%.

And the reason so many jobs are being created is because we have a systemic worker shortage.

That doesn’t help the fight against inflation – and it’s actually something the Fed is targeting. The Fed wants to bring unemployment up.

But the biggest thing the bull case fails to explain is why valuations are right back to where they were at the peak of the “everything” bubble of 2021. That’s an incredible feat considering we just came out of the bubble a year ago.

And that fact should have every investor up at night.

Take a look at this chart…

This recent price explosion has not come on the back of rising earnings or even expectations of rising earnings.

Prices have gone up but earnings expectations have dropped.

And in the earnings releases this quarter, frequent cuts-to-revenue projections have been the norm. Companies found favor with investors through cost-cutting and downsizing instead.

But that strategy’s incremental boost to margins can only take them so far. Eventually, top-line growth becomes a necessity.

So Where Do We Go From Here?

There’s a saying… Don’t forecast the market using data that the market itself forecasts – like earnings and economic data.

If you do make that mistake, you’ll assume earnings expectations will improve once analysts wake up and smell the bullish coffee.

But CEOs are driving these earnings estimates. And they are much closer to the action than the analysts at their Bloomberg screens. These CEOs are forecasting the same thing – a big growth slowdown.

Stock prices tend to reflect the emotions of the people that trade them. They divert from the underlying forces that ultimately dictate their worth.

In short, stocks tend to get out of whack pretty quickly… And there’s been a lot of pent-up demand to “go long.”

So chasing this rally is almost guaranteed to fail… There will be lower prices up ahead.

And one thing is certain… A 26 price-to-earnings (P/E) ratio – back where it was in 2021 – will not stand for long in a tightening cycle.

Regards,

Eric Shamilov
Analyst, Trading With Larry Benedict

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