Updated January 24, 2023
Raymond Micaletti, Ph.D.
In recent weeks it’s become evident that institutions have been positioned for a soft landing, despite a still-hawkish Fed and widespread expectations of a recession.
For the most part, recent market action—e.g., higher equities, weaker dollar—and economic data have supported that institutional positioning.
Indeed, as discussed in last week’s commentary, the market experienced a Breakaway Momentum breadth thrust on January 12 (as well as several other similar thrusts). Such breadth thrusts have almost always led to sharply higher equity prices 12 months onward.
But last week the emerging narrative of a soft landing took a hit. On Wednesday, core retail sales and industrial production came in way below expectations. Those surprises ignited fears of a hard landing and sent the S&P 500 down 1.5% that day and down an additional 1% Thursday morning. By Friday’s close, however, the market had rebounded to finish at its 200-day moving average (3972), down modestly (0.6%) on the week.
Friday was the monthly options expiration and options dealers stood to profit the most if the S&P 500 finished at 4000—that might partially explain the rebound Thursday afternoon into Friday.
But despite the intra-week selloff, the market continued to drop hints that its likely direction continues to be higher.
One such hint was that the tech-heavy Nasdaq outperformed the S&P 500 on Wednesday (the big down day) and finished up on the week (+0.6% vs. -0.6% for the S&P 500). It was the first time in a year the Nasdaq was up on a week the S&P 500 was down.
What drove the Nasdaq’s outperformance? As Matt Reiner at JPMorgan wrote this week:
“Something I’m noticing in Tech, and don’t think many are talking about it – [long-only institutions] are quietly adding in Mega[-cap] names, and consistently too – The demand has been on and off the desk now since Jan 2 this year, but the numbers are starting to add up.”
In other words, institutions (large asset managers, insurance companies, endowments) are buying mega-cap tech names (e.g., Google, Amazon, Meta, Apple).
While one could argue those mega-cap names are still richly valued (and likely to fall further), one also has to acknowledge that those stocks have fallen anywhere from 31% (Apple) to 77% (Meta) from their all-time highs– (Microsoft -37%; Google -44%; Nvidia -66%; Amazon -56%; Tesla -74%; Netflix -76%)—and thus may be overdue for a cyclical rally.
Two weeks ago we noted The Market Ear had said:
“Friday’s [tech] 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…”
…and further that Goldman had reported some of the biggest retail outflows from technology stocks on record. We quipped that “the market likes nothing more than to scare retail traders out of their positions at market bottoms and FOMO them in at market tops.”
Since that commentary, the Nasdaq 100 is up 5% and retail traders may soon be regretting having dumped all their tech stocks.
Netflix reported earnings last week and the market responded favorably, bidding up the stock 8.5% on Friday. This week Microsoft and Tesla will report, and next week Apple, Amazon, and Google will do the same.
The fact that long-only institutions are putting money behind these mega-cap tech names before earnings suggests those earnings will be in line or better than expected. Given the cost-savings from the tens of thousands of layoffs by the likes of Google, Microsoft, Amazon et al. in recent months, these institutions could very well be right.
Institutions buying tech also suggests real interest rates will continue to decline (tech tends to do well when real interest rates fall), which in turn suggests the Fed is closer to the end of its hiking cycle than the Fed itself would care to admit.
With respect to the hiking cycle, inflation appears to be doing its part by falling. The question is whether the U.S. fiscal situation—which has seen more Treasury issuance than previously estimated and much lower tax receipts in 2022 (because of falling asset prices)—can withstand higher interest rates for longer without causing bond market instability.
The smart money appears to be saying, “No.”
With respect to the fiscal situation, we now have the debt ceiling standoff in D.C. While that persists, the U.S. Treasury has $377 billion in its account (as of Friday) to redeem any maturing debt (before the ceiling is raised once again). As the Treasury redeems maturing debt, that is functionally equivalent to quantitative easing and will continue to loosen financial conditions.
With respect to the Fed, most Fed speakers last week advocated for a 25 basis point rate hike at the February 1 meeting, in line with market expectations. The Fed will be in its blackout period this week, so the market won’t have to worry about any hawkish jawboning.
In light of all this, what did the smart money do last week? They bought equities and sold dollars. It marks the fourth time in five weeks that institutions have added to their net long equity position. And speculators in the dollar show no concern the dollar selloff might reverse.
Looking at other growth- and liquidity-related assets (e.g., commodities, currencies, short-term bonds), smart money is positioned in a “risk-on” way in all of them. They’re not yet heading for the exits. If anything, they are doubling down on the likelihood of a soft landing—or at least the appearance of one that will (presumably) cause equities to rise.
Retail sentiment in commodities is in the Goldilocks zone for equities—neither too hot nor too cold. Despite the retail sales and industrial production disappointments last week, other economic data came in as expected or better (for example, new unemployment claims), which supported the soft landing narrative.
This week we’ll get our first look at Q4 GDP, which the Atlanta Fed estimates at 3.5%. We’ll also get a large serving of S&P 500 earnings announcements.
Thus, by the end of the week, we should have a better idea whether the soft landing narrative will gain even more traction or whether it will be replaced by a hard landing narrative.
Given the way the smart money has made its bets, one has to think the odds favor the soft landing narrative.
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