Toto … I Have a Feeling We’re Not in Jackson Hole Anymore

DJIA:  34,395

Toto … I have a feeling we’re not in Jackson Hole anymore.  Though brief, Powell’s comments back then sent the market reeling some 1000 Dow points just that day, and another 1300 points into the October low.  So what got the market up 700 points on Wednesday?  Granted the speech had a conciliatory tone, but the rally may not have been about the speech at all.  The market, simply put, was loaded for bear.  The Dow had fallen 500 points on Monday, was down most of Tuesday, and was even down 300 points before Powell’s comments.  It’s not exactly a stretch to say expectations were low.  To give the market its due, the overall technical background had seemed sound coming into the week.  And the good news about the speech – it’s over.

Diamonds recently have been everyone’s best friend.  The “diamonds” we are referring to are the ETF for the Dow Jones Industrial Average, the symbol for which is DIA (344), hence diamonds.  It’s surprising to realize the Dow is down only about 5% this year and, therefore, your best friend.  That’s all the more true considering the S&P is off 14% and the NAZ some 30%.  The secret of the Dow’s success is pretty clear, Microsoft (255) is the only Tech among its top 10 holdings.  As you probably know, the Dow has the quirk of being price-weighted, making a $500 stock like United Healthcare (537) its largest holding.  Also among the top 10 holdings are companies like Caterpillar (236) and Honeywell (217).  Meanwhile, the Nasdaq is referred to as “tech heavy,” and Tech has made it just that.  While the S&P obviously is broader and more diversified, it is market cap-weighted making a stock like Apple (148) 7% of the Index.

A few weeks ago, courtesy of, we pointed out that Materials had made a remarkable turnaround.  In less than two months every stock in the group had gone from below its 50-day moving average to above that average.  There is a small sample here, but all of the occurrences showed positive returns in the next 2 to 12 months.  A somewhat similar pattern now has occurred with Industrial stocks.  As of last week nearly all had climbed above their 50-day while less than two months ago only 3% had done so.  A similar pattern occurred in August with poor short-term results, but over the last 70 years the pattern preceded six-month gains every time.  Another positive here is that both XLI (102) and XLB (83) have moved above the 200-day moving average as well.

To look at the SPDR Energy ETF (XLE-91), Oil isn’t what it used to be.  And yet the ETF is simply consolidating, and doing so less than five points from its high.  That said, it is doing so while only just back to the high in June, and that after a couple of nasty drawdowns.  Meanwhile, the January to June rally had been one of the most consistent and orderly uptrends we’ve seen in sometime.  Uptrends, of course, all have their corrections.  The fact that XLE has made it back to the highs seems very positive.  Of late a concern has been the divergence between the stocks and the commodity – down 4% and 40%, respectively.  Some say this reflects a newfound religion among producers.  We say the stocks just might have it right, and the commodity will follow.

News out of China sent markets lower Monday, though we’re not sure that too wasn’t more to do with Powell phobia.  And at least for the S&P and its 200-day, reminiscences of last August could have had something to do with it as well.  There is, however, an important difference between now and last August – S &P stocks are outperforming the S&P Index.  While the Index still struggles with its 200-day, more than 60% of its components are above their 200-day.  Typically, participation is the key, and that’s why 5-to-1 Advance/Declines is important as well.  The number of S&P stocks above the 50-day also is impressive, having cycled from 3% to close to 90%, another pattern with positive 6 – 12 month results.  The shift in momentum for both the XLI and XLB also augers well for year-end results.  As Thursday once again made clear, however, nothing in this market comes easy.

Frank D. Gretz

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US Strategy Weekly: Follow the Earnings

The Dudack Research Group wishes you and your loved ones a happy and healthy 2022 holiday season and a delicious and restful Thanksgiving weekend. We at DRG are grateful for many things and most especially for your continuous support and patronage.

Bear Markets and Transitions

Bear markets have a multitude of catalysts, but history shows that the most significant bear markets are triggered by one of two factors. A bear cycle often begins after an immense accumulation of debt and leverage that leads to massive defaults, a sharp decline in demand, a period of deflation, and falling profits. Or conversely, a bear cycle is triggered by a huge supply/demand imbalance that leads to an inflationary cycle, a loss of purchasing power, profit margin pressure, declining earnings, and lower PE multiples. The inflationary cycles of 1970-1974 and the current bear market were clearly linked to inflation driven by a lack of supply of oil. However, inflation preceded Russia’s invasion of Ukraine and most of today’s price cycle is due to the historic monetary and fiscal stimulus undertaken around the world to combat the worldwide economic shutdowns. In short, political decisions played a large part in today’s inflationary cycle.

But perhaps the most important characteristic of any bear market is that it almost always results in a major shift, or transition, in market leadership. It is this transition in leadership that is the key to outperforming, not only during the bear market, but in the bull market that follows.

Follow the money” is a phrase that solves many financial and political mysteries, but “follow the earnings” is the simplest way to understand the leadership emerging in the current cycle. In 2020 our favorite sectors were those we described as “inflation-resistant” segments of the economy. In 2021 and 2022 we emphasized “recession-resistant” sectors and stocks for outperformance. Not surprisingly, inflation-resistant also tended to be recession-resistant and included sectors such as energy, utilities, staples, defense, and aerospace. These sectors can also be called defensive, household necessities, value, and total return, but they are most importantly the areas that have pricing power and profits in an era of rising costs and shrinking margins. Segments of healthcare can also be defensive and weather both inflation and recession. Technology has defensive segments such as security technologies. But in every case, it is a stock or sector with a predictable earnings stream in what is a difficult and unpredictable economic time.

Earnings Insecurity

The third quarter earnings season seems to have sounded the alarm that earnings are at risk for this year and next. In the last five weeks, the S&P Dow Jones consensus earnings estimate for 2022 has declined 3% — an unusually large decline in a short period of time. However, the erosion in forecasts actually began in April when estimates were 12% higher than they are today. We lowered our 2022 and 2023 earnings estimates two weeks ago to adjust for the weakness seen in the third quarter results. Unfortunately, the S&P Dow Jones estimate has dropped so quickly (it is now $201.58) that it is already below our $202 estimate for the S&P for this year. Although seasonality for the next three and six-month periods tends to be positive, the underlying erosion in earnings could prove to be quicksand for the overall market. Again, safety is equal to finding companies with solid earnings streams. See page 6. Unfortunately, the increase in interest rates and decrease in earnings estimates seen this year has lowered the midpoints of our valuation model to SPX 2625 for 2022 and to SPX 3020 for 2023. See page 7. In short, risk continues in the first half of 2023.

Real Estate Recession

There is little doubt that residential real estate and the homebuilding sector is in a recession. In September, new home sales fell 18%, the median new single-family home price fell 14% YOY, and the average home price fell 10% YOY. Existing home sales fell 28.4% YOY in October and the median existing single-family home price rose 6% YOY. See page 4.

A lack of inventory has been supporting existing home prices this year, however, that too is beginning to change. According to the National Association of Realtors, the months of supply of inventory have increased from the cyclical low of 1.5 in January of this year to 3.3 months in October. Housing starts were down 8.8% YOY in October and new home permits were off 10% from a year earlier. See page 5. And the outlook for the housing sector in 2023 continues to be dim, particularly since the Federal Reserve is expected to continue to raise rates in coming months. Affordability is already at its worst level in 37 years and the NAHB builder confidence survey has been declining for 11 consecutive months. November’s survey fell 5 points to 33, which is well below the neutral benchmark of 50. Both current traffic and the outlook for sales in the next six months are at recessionary levels. See page 6. Keep in mind that these dismal numbers are likely to get worse due to the Fed’s tightening policy in coming months. But, to a large extent this is the Fed’s goal – an economic slowdown.

October’s retail sales were stronger than expected, with total retail and foods service sales increasing 8.3% YOY and total sales excluding autos and gas stations rising 8% YOY. However, retail sales priced in 1982 dollars (adjusted for inflation) rose a mere 0.5%. Still, this small increase was better than the real retail sales data for April and June which were negative on a year-over-year basis. These declines were worrisome since negative YOY retail sales have been characteristic of all previous recessions. See page 3. However, investors should focus on where retail sales have actually been growing. In the post-COVID era. Sales have increased for six segments: gas stations, food service, building materials, sporting goods, miscellaneous and non-store retailers. This is in line with what we are seeing in terms of stock performance. See page 14.

Technical Watch

What we are seeing in terms of earnings performance is playing out in the popular indices. On page 9 we have ordered the indices in terms of their technical strength. The DJIA is by far the best-performing index, seen by the fact that it is now trading above its long-term 200-day moving average and has broken above a downtrend line off the January 4, 2022 peak of 36,799.65. The Russell 2000 index is the second-best performing index and is threatening to break above its 200-day moving average but is yet to do so. The S&P 500 is third best, and while trading above both its 50 and 100-day moving averages, it is trading 60 points below its 200-day moving average. The Nasdaq Composite index is by far the worst-performing index. It has barely exceeded its 50-day moving average and trades well below its 100 and 200-day moving averages. These differences are a display of the shifting leadership we noted earlier. Value has widely outperformed growth year-to-date and during the recent rally. See page 9. The 25-day up/down volume oscillator is neutral at 2.28 but was overbought for five of the last eight trading days. This is significant since bear markets rarely reach overbought territory and if they do the reading is brief. A true overbought reading should persist for at least five to ten consecutive trading days to be significant, therefore, the recent reading is ambiguous. Nevertheless, this will be a key indicator to monitor in the coming weeks to assess the strength of any advance in prices.

Gail Dudack

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Don’t Fight the Fed … But Don’t tell the Market.

DJIA: 33,546

Don’t fight the Fed … but don’t tell the market. Despite the Fed’s hammering it’s not done, for the most part it seems to be falling on a market without ears. Or, is it a market that sees more than the Fed? Ironically, most are seeing it the Fed’s way, when the Fed doesn’t exactly have the best record here. Then, too, history is replete with rallies in bear markets. And the idea that most of the best one day rallies happen in bear markets has to make you wonder about last week’s 1200 point CPI gain. We get all of that, but this time there’s a bit of a difference. This is not about one day, this time stocks above their 200-day moving average have cycled from 12% to above 50%, a dramatic improvement. Historically, readings above 60% have been followed by above average forward returns, and spikes above 70% have marked new bull markets.

When it comes to stocks in general, it pretty much comes down to the haves and the have nots. More recently, it might better be said of the former, the have hads. These are the stocks that have held well through the weakness but recently have corrected. These would be names like McDonald’s (273) and PepsiCo (180), and certainly the healthcare names which have turned surprisingly weak. Meanwhile if we go through our list of potential short sales, there are virtually none left. We are told Goldman has a basket of most heavily shorted stocks which was up 10% one day last week. Another proxy for this kind of stock is Cathie Wood’s ARKK ETF (37), which recently was up more than 20% from its low a week ago. As we pointed out, often down the most turns to up the most. Meanwhile, what likely still are the leaders take a breather.

It might be time to get back to basics. You probably don’t spend too much time pondering Sherwin Williams (237), let alone Ecolab (148) and Linde (330). They are a part of the SPDR Materials ETF (XLB – 79), which has gone from no components above their 50-day, to all components above their 50-day. Over the past 70 years this shift has happened only a few times and, in this case, in less than six months. Like virtually all of these momentum shifts, positive returns were seen over the next year, according to Moreover, at no point was there a drawdown greater than 5%, while all showed gains of 15% or more. LIN is the largest position of XLB, and probably the best chart. Among the top 10 holdings are Freeport McMoran (36) and Nucor (142), both beneficiaries of a better China. In regard to the steel stocks, you might also look to the ETF there (SLX – 59).

We know the stock market can be more than a little perverse. When everyone is bearish that’s a good thing, but at least we know why. When everyone is bearish the selling gets done and it’s that selling that makes a low. We’re not quite sure why but consumer sentiment seems to work much the same way. The latest University of Michigan Survey showed depressed readings on present and future intentions. A six month average has now dropped to the lowest on record, exceeding the worst pessimism during the financial crisis and the S&L mess years ago. Other than being early in the financial crisis, all coincided with the end of bear markets, or were close.

They don’t let up – they being the Fed. If they’re not raising rates they’re talking about raising rates. Both have their impact on markets but so far at least, only temporarily. The Fed doesn’t want to see the market up, the wealth effect we suppose. As it happens, it’s the home builders that have been most affected by higher rates, and those stocks are all up from late October. Of course, everything is up from June when nearly 50% of all stocks made a 52-week low. We doubt we’re going back there, so you might argue the bear market is over. There’s a difference, however, between putting in a low and starting a new uptrend, a new bull market. Let’s talk about that when we get to 70% of stocks above the 200-day. In the meantime, suffice it to say they look higher and will continue to look higher until something changes, likely the A/Ds. Strength in the averages needs corresponding strength in the average stock.

Frank D. Gretz

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US Strategy Weekly: Transition of Leadership

Breaking News

As we go to print there are a number of news headlines of significance. Unconfirmed reports suggest that a Russian-produced missile hit a Polish village near the border of Ukraine, killing two Polish citizens. This incident sparked a flurry of NATO leaders declaring that all NATO territories must be defended and as a result, fanned fears of an escalation and/or expansion in the Russia-Ukraine conflict. News of this explosion in Poland aborted an early-day rally that had been kindled by better-than-expected third quarter earnings from Walmart Inc. (WMT – $147.44).

Later this evening former President Trump is expected to announce his intention of running for re-election in 2024. This could split the Republican Party which is already showing signs of post-election fatigue and upheaval. The midterm elections did not produce a red or blue wave, but it is expected to create a shift in leadership in Congress. Rick Scott (R – FL) announced he will run against Senate Republican Leader Mitch McConnell (R – KY) for the role of minority leader in the Senate. And if the Republicans edge out the Democrats in the House of Representatives, Kevin McCarthy is expected to take the role of Speaker of the House from the indefatigable Democrat Nancy Pelosi. New leadership in Congress is unlikely to generate a meaningful difference in policy, but it is reassuring that a divided Congress is usually seen as a positive for the equity market.

These news events took the attention away from the collapsed crypto exchange FTX which has dominated financial news in recent days. The exchange, among the world’s largest, filed for bankruptcy protection on Friday after traders pulled $6 billion in three days from the platform and rival exchange Binance abandoned a possible rescue deal. FTX is the highest-profile crypto blowup to date and bankruptcy filings indicate the exchange faces a “severe liquidity crisis” and could have more than 1 million creditors. This is a warning of possible liquidity issues in unsuspected places in the upcoming weeks. Meanwhile, it is possible that FTX founder and former chief executive Sam Bankman-Fried will face felony charges due to what might be “unauthorized transactions” on its platform.     

The Rally

News of the wayward Russian missile threw a curve ball in what appeared to be an improving outlook for the Russia-Ukraine conflict. The retreat of Russian troops from Kherson left Russia with no forces on the right, or western, bank of Europe’s third largest river that bisects Ukraine and flows into the Black Sea. This is a vital conduit for Ukrainian grain exports. In fact, there were unsubstantiated reports that an agreement might be possible between Russia’s Putin and Ukrainian President Volodymyr Zelensky. We believe this possibility contributed to the massive rally in the euro and the decline in the dollar last week. This prospect, coupled with short covering, were catalysts for the rally in equities last week.

Yet stocks rose for a number of reasons including financial headlines like “US Fed could soon start easing rate policy.” We found this headline to be very misleading. Using the word “easing” in terms of monetary policy translates directly into the prospect of the Fed lowering interest rates. However, in this case, the media is actually referring to the possibility that interest rate increases could get smaller. However, these are two very distinct and different concepts. We question whether this headline was intentional and thereby playing with investor psychology or was it simply a symptom of naïve and inexperienced journalism. We do not know, but we do know that the market responded as if interest rates were about to decline. This makes us nervous about the rally.

Higher Interest Rates Ahead

As noted, investors celebrated better-than-expected CPI data for October with a massive rally, but as seen on page 5, the improvement was minor. Headline CPI was 7.8% YOY in October versus 8.2% YOY in September. Core CPI rose 6.3% YOY versus the 40-year high of 6.6% recorded in September. PPI data was somewhat better since it is coming down from cyclical highs recorded in June. In October, finished goods PPI rose 11.2%, core finished goods rose 8.1% and final demand PPI rose 8.0% YOY. Yet clearly, these rates remain well above the long-term average of 3% and remain at the highest pace in 40 years.

What is important to emphasize is that core CPI (6.3% YOY) and core PPI (8.1% YOY) remain well above the pace of wage growth (4.8% YOY) and this means household purchasing power continues to erode. This has been and will be a factor that will weigh on economic growth in the coming months. See page 6.

Another consideration that will slow economic activity is steady monetary tightening. Recent inflation data indicates that the fed funds rate continues to be negative and as a result, the Fed is not expected to stop raising rates in the foreseeable future. See page 7. All in all, we question the validity of the discussion around a Fed pivot. Even though the pace of interest rate increases may slow, this has very different implications from a reversal in interest rates. Sentiment on monetary policy is too optimistic, in our view. The Fed will continue to raise interest rates and depress economic activity in coming months making a recession likely in 2023.

Meanwhile, consumer and business confidence continue to erode. NFIB’s Small Business Optimism Index declined 0.8 points in October to 91.3, the 10th consecutive month below the 49-year average of 98. Of the 10 Index components, two increased, seven declined, and one was unchanged. Small business earnings and sales are at levels last seen during the 2020 recession and employment plans are declining. See page 3. Headline University of Michigan consumer sentiment hit a record low of 50.0 in June before rebounding. Nevertheless, it fell from October’s 59.9 to 54.7 in November. Economic expectations in the University of Michigan and Conference Board consumer sentiment indices, as well as the small business survey, have been falling nearly every month in the last two years. See page 4.

Technically Good News

The 25-day up/down volume oscillator is currently overbought for the third consecutive trading day with a preliminary reading of 3.83. This is significant because bear markets rarely reach overbought territory and if they do the reading tends to be modest and brief. In sum, this will be a key indicator to monitor in the coming days to assess the strength of any advance in prices. A long and extreme overbought reading would change our view of this rally merely being a strong bear market rebound. We will keep you posted.

In the interim, it is clear that this bear market has defined a transition of leadership. The FANG phenomenon is over. This new cycle is shifting from classic growth to value, from large capitalization to mid-to-small capitalization, and from global to domestic. We continue to favor recession-resistant areas such as energy, utilities, staples, aerospace and defense and recession-proof healthcare. 

Gail Dudack

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US Strategy Weekly: Lowering EPS Estimates Again

Politics and inflation are the features of this week; however, third-quarter earnings results continue to provide plenty of drama in the background.

Politics and Equities

In terms of this week’s elections, a number of strategists are noting that since WWII, the S&P 500 has had a perfect record of gains following the midterm elections. In addition, the S&P 500 has posted an increase in each of the 12-month periods after the midterm vote and these gains have averaged an impressive 15%. As we show on page 3, the fourth quarter of the midterm election year tends to be the best fourth quarter of any of the four years in the election year cycle. And more importantly, the first quarter of the pre-election year tends to be the best quarter in the entire election cycle for most of the popular indices. In short, the last quarter of 2022 and the first quarter of 2023 are periods that have a solid history of being strong periods for stock prices.  

To date, 2022 has been very volatile and has underperformed historical averages. This severe underperformance is best displayed by the chart on page 4. However, it is this underperformance that may have led to the strong rebound seen in October. Yet even apart from politics, November marks the start of the best 3-month and 6-month periods for equity prices. In short, the stock market should have the wind at its back in the coming months.

And we do not see anything in terms of election results that could hamper stock prices. History shows that equity investors tend to like a split Congress. According to Reuters, when a Democrat is president, the market performs best when Republicans hold either the House, Senate, or both. The average annual S&P 500 returns have been 14% with a split Congress, 13% with a Republican-held Congress, and a 10% gain when Democrats control both the White House and Congress. All in all, the midterm elections should have a positive effect on investor sentiment.

Earnings Revisions

While we do expect the election to be a positive for equities, we are less optimistic about the next six to twelve months due to the deterioration we see in corporate earnings. The steady decline in S&P 500 earnings for this year and next year has continued as the third-quarter earnings season passes its midpoint. This week the S&P Dow Jones consensus earnings estimates for 2022 and 2023 fell $0.57 and $2.76, respectively. Refinitiv IBES consensus earnings forecasts fell $0.36 and $3.28, respectively. What is notable about the last two weeks’ revisions is not just that they continue to fall but that estimates for 2023 are beginning to plummet. As a result, the 2022/2023 forecasts from S&P Dow Jones and IBES Refinitiv are now $204.17 and $230.11 for 2022 and $220.91 and $232.64 for 2023. Earnings growth rates for 2022 are (1.9%) according to S&P and 6.1% according to IBES.

We have been stating that our S&P 500 earnings estimates would be reviewed after third quarter results, however, results have been so poor that we believe our earnings estimates need addressing this week. Our 2022 and 2023 estimates are slashed this week from $209 to $202 and from $229 to $204, respectively. The decline in this year’s estimate reflects the weakness seen in 2022 earnings results to date. More importantly, and more dramatically, our revision for 2023 earnings is due to the negative impact we expect to see from current and future Fed rate hikes on economic activity. Although some economists are now placing odds on the ability of the Fed to maneuver a soft landing in 2023, we believe many parts of the economy are already in or will inevitably face a recession. As a result, this will continue to put pressure on consumers and therefore on top-line revenue growth. Plus, inflation will continue to pressure corporate profit margins. For these reasons, we continue to favor the more recession-resistant areas of the stock market such as energy, utilities, staples, and defense stocks. Healthcare is a DRG-neutral weighting (see page 13) but many health-related stocks are necessities and are therefore recession resistant. Note that this means one should emphasize value versus growth and growth at a reasonable price.

In terms of the economy, the ISM nonmanufacturing survey’s composite index fell from 56.7 to 54.4 in October and the details of the report were unfavorable. New orders and business activity declined, and employment slipped below the neutral 50 mark. Note that the service sector, which has been the relative outperforming sector of the US economy, now appears to be joining the manufacturing sector which has been in decline since early 2021. See page 5.


The jump in short-term interest rates from nearly zero to 4.2% is currently having and will continue to have a dramatic impact on equity valuation. The current earnings yield of 5.4% and dividend yield of 1.8% still hold a slight edge over bonds, but this will continue to evaporate as interest rates rise and earnings forecasts fall. When we put our revised earnings forecasts of $202 and $204 into our valuation model, coupled with our estimates for headline CPI of 7.1% this year and 4.0% next year, and short-term interest rates of 4.75% this year and 5.0% for next year, equity valuations fall. The midpoints of our valuation model drop to SPX 2666 for 2022 and to SPX 3020 for 2023. In sum, equity risk due to inflation, rising interest rates, and falling earnings continues. See page 7.  

Technical Indicators Remain Interesting

The charts of the popular indices are as revealing as many of our technical indicators this week, and each tells a slightly different story about the equity market. On page 8 we have ordered the charts of the indices in terms of technical strength. The DJIA is the strongest index and has just exceeded its long-term 200-day moving average this week. It is less than 3% above the moving average that confirms a breakout, nevertheless, it is trading above all its moving averages. The Russell 2000 is approaching its 200-day moving average but remains below it. The S&P 500 continues to find resistance in the narrow range between its 50-and-100-day moving averages. And lastly, the Nasdaq Composite is the weakest of all the indices and is trading well below all its moving averages. This divergence in the indices is a demonstration of shifting leadership from growth to value. 

The 25-day up/down volume oscillator is currently neutral with a reading of 1.11. Last week we noted that the indicator was rising toward an overbought reading of 3.0 or greater, which could signal a turning point for the market. The significance of an overbought reading is that bear markets rarely reach overbought territory and if they do the reading is brief. However, in recent days this indicator retreated before reaching overbought territory – a sign of decelerating buying pressure on the rally. Nevertheless, this indicator will be important to monitor in the coming weeks since it could be a bellwether of the strength of future advances in prices. See page 9. With many indices at, or near resistance levels, it will be important to see if this week’s inflation data has a significant impact on investor sentiment.

Gail Dudack

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Hope Springs Eternal … Or Do We Mean Wishful Thinking

DJIA: 32,001

Hope springs eternal … or do we mean wishful thinking? With the apparent exception of Jay Powell, we all have learned if you have nothing nice to say, and so on. And that pretty much sums up the Fed meeting. Yet the market seems to have had in mind that it wanted to go higher. Clearly it didn’t on Wednesday, and clearly it didn’t take the opportunity to ignore bad news, as good markets sometimes do. Some dust now likely has to settle. So how can these pivot hopes be dashed so many times, and yet the market keeps coming back for more? Possibly the market just sees what it wants to see, or possibly it sees more. Possibly it sees inflation has peaked and the typically late Fed will have to pivot. Or, maybe that really is wishful thinking. To channel Mick Jagger, stay off of my cloud, and the rest of Tech. They say things change, and they have. From the M word being Microsoft (214), to the M word being McDonald’s (273). Both are in big overall uptrends, the difference is MCD is at the top of that trend. A burger and a Coke may hit the spot, but a burger and a Pepsi (178) is even better – the latter is another all-time high. According to Barron’s 27% of packaged food stocks hit 12-month highs last week. Hershey (232) looks like Microsoft in days of old. Technically speaking it’s not difficult to see these stocks continuing their outperformance. After all, it has been all about Tech for so long some change seems overdue. And that often comes about out of corrective periods. Together with the market’s somewhat more conservative leaning, and with help from those that are its namesake, the Dow Industrials are on a tear. Unlike the dot-com/new economy days, the Dow isn’t exactly old economy. Indeed the Cisco (44), Microsoft and Salesforce (146) positions are new relative to those good old days. It does seem fair to say, however, the Dow for the most part is a different economy, different for sure from the NAZ economy. To that point, over the last 30 days through Tuesday, the Dow relative to the NAZ was up more than 10%. Take that you Tech geeks. It was even up more than 5% against the obviously broader-based S&P. It’s too soon to call the revolt durable, but it is something to consider. And in the case of McDonalds and Pepsi, what’s the risk – these are NAZ looking charts anyway. The main thing going for the market has been the seemingly washed out price action. There is, however, some sign of positive momentum in terms of stocks reaching 52-week highs. In September there were a third more stocks trading at new lows versus new highs, a historical extreme. Following similar extremes the S&P’s one year return was 25%, according to This week the number reversed, with more stocks trading at new highs. As one would expect, returns against this backdrop are about twice that when new lows dominate. The change is a tentative one but still seems important. With the exception of some of the obvious names, even Tech is in the same position. The percentage of stocks at new highs minus lows turned positive after one of the most negative readings since the inception of the Nasdaq In 1985. We still have a ways to go, Powell said. It was another Fed to the market slap down, in this case to the. S&P’s one percent afternoon rally. Nothing new except a little misguided exuberance. And the Fed did add the phrase “cumulative tightening” to the statement, suggesting a need to judge what effect they’re having before continuing their serial tightening. It wasn’t a PIVOT, but maybe a PIV. As we say about the big up days, one day is just that. Worry less about the Fed and more about those A/D numbers. Up in the averages with lagging A/Ds is never good, regardless of the Fed. Meanwhile, oil and the like doesn’t seem to want to quit.

Frank D. Gretz

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US Strategy Weekly: A Week of Important Tests

This week is significant since it marks the heaviest five days of the third quarter earnings reporting season. It also includes the November FOMC meeting and October’s employment report and precedes the midterm election on November 8. Each of these issues has ramifications for the equity market, but in our view, earnings reports should have the biggest short- and long-term impact on stocks.

The Importance of Earnings

To date, third quarter earnings results are coming in lower than much-reduced expectations. Last week the Refinitiv IBES estimates for this year and next fell $0.87 and $2.86, respectively. The S&P Dow Jones consensus estimates, which are important since S&P follows GAAP methodology, fell $2.00 and $2.52, respectively. As a result, the respective consensus estimates for this year are currently $221.27 and $204.70, which represent growth rates of 6.3% YOY for IBES and negative 1.7% YOY for S&P. See page 8. The steady decline in earnings estimates is a concern because we believe bear markets bottom out when the outlook for valuation is improving, or at least hopeful. Unfortunately, assuming the Federal Reserve will raise interest rates this week and again in December, and since rising interest rates suggest a weaker economy in 2023, the outlook for earnings is not optimistic. As a result, estimates for 2023 earnings are probably still too high and one can expect more negative surprises in the quarters ahead. Earnings disappointments erode investor confidence over time. In the short run, this week’s battery of earnings reports could set the tone for whether there is hope for 2023 earnings, or if estimates are still too high.

Nonetheless, our skepticism on S&P 500 earnings is not broadly based. In fact, we have been in favor of recession-resistant sectors and seek stocks where earnings growth is most predictable. In general, the current economic environment favors value stocks versus growth stocks, and we have been emphasizing necessities such as energy, staples, defense/aerospace, and utilities. The utility sector has shifted from being an outperformer to an underperformer in the last month, but keep in mind that “performance” in utilities should not be measured just by price, but by total return. We have a neutral weighting on healthcare, however, since healthcare is another household necessity with pricing power, it should not be overlooked in our view. See page 13. From a historical perspective, bear markets tend to be a transition period for a significant shift in leadership. We believe this is true of the current market. Notably, S&P sectors labeled as “growth” have varied over the decades, but they have had one thing in common and that is that they have represented the highest earnings growth rates of all 11 S&P sectors. In the next few years, or at least until inflation has come under control, we believe recession/inflation-resistant companies will provide the best earnings and price performance and will outperform the S&P 500 index. In truth, energy has been the growth sector of 2021 and 2022.

A Fed Pivot

The Federal Reserve is expected to raise the fed funds rate from its current range of 3% to 3.25% to 3.75% to 4.0% this week. This would be the fifth interest rate hike in a twelve-month period and the fourth consecutive 75 basis point increase this year. It would also constitute an increase of 375 basis points in the last 20 months. This will certainly have a major dampening effect on economic activity in the first half of next year and it has already put the residential real estate market in a recession. We would challenge market pundits who are focused on whether a 50-basis point increase at the December FOMC meeting would constitute a “Fed pivot” and a key buying opportunity, because we believe this misses a very important point — a 375-basis-point increase in the fed funds rate in a mere twelve months is likely to trigger a recession in 2023. Again, there are many reasons to focus on recession and/or inflation resistant companies at this juncture, even though we would note that the best three-month period for stocks (November, December and January) has just begun.

A Critical Technical Juncture

Technical indicators are at an interesting and, in some cases, critical juncture just as important information from earnings, the Fed, economic data, and political elections loom on the horizon. The most important indicator this week is the 25-day up/down volume oscillator which is currently neutral with a reading of 2.61. However, this is surprisingly close to an overbought reading of 3.0 or greater. Since bear markets rarely reach overbought territory and if they do the reading is brief, there is the possibility of a turning point in this indicator. In sum, we will be watching the 25-day up/down volume oscillator very carefully in coming weeks.

And as the oscillator faces a potential turning point so does the S&P 500 index. A convergence of the  50- and 100-day moving averages at roughly SPX 3900 represents a key resistance level. If bettered, it would be a positive for the intermediate-term outlook and fall in line with the favorable seasonality that is typical of year end. If it proves to be resistance, it will confirm that the bear market cycle remains intact. See page 9. Nevertheless, the indices are not moving in unison, and it is worth noting that the DJIA is trading above its shorter-term moving averages and currently testing its 200-day moving average. The Russell 2000 is similarly close to its 200-day moving average. This divergence and relative outperformance of small capitalization stocks is favorable since the large capitalization stocks tend to be the last to fall in a bear market.

Economic Data

After contracting in the first two quarters of the year, GDP grew 2.6% (seasonally adjusted annualized rate – SAAR) in the third quarter. However, trade contributed 2.8% to the quarter as exports of oil & gas to Europe increased and a strong dollar translated into fewer dollars spent on imports. In short, these may be short-term influences and the domestic economy continued to struggle. See page 3.

Household consumption contributed less to third quarter activity than it did in the second quarter and consumer spending was disproportionately in services. Businesses slashed spending on structures and residential investment fell at a 26.4% annual rate. Residential fixed investment was the largest drag on third quarter GDP falling 1.4% (SAAR), followed by inventories which fell 0.7% (SAAR). Third quarter typically sees an inventory build ahead of the holiday season; however, real retail sales have been weak in recent months and retailers appear to be cautious. The one bright spot in the GDP report was a small decline in the GDP deflator from 7.6% to 7.0%. See pages 4 and 5.

In September, personal income grew 5.2% YOY and personal disposable income grew 3.2% YOY. But the true measure of household consumption is demonstrated by real personal income which declined 1.0% YOY and real disposable income which fell 2.9% YOY. See page 6. Yet despite a lack of purchasing power, personal consumption expenditures rose 8.2% YOY in September and grew 8.4% over the last three months. Not surprisingly, the savings rate fell from 3.4% to 3.1% in the same month. Overall, consumption may not be sustainable at this level.

Gail Dudack

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Bad News …It Doesn’t Have To Be Bad

DJIA:  32,033

Bad news …it doesn’t have to be bad.  After all, the market makes lows on bad news, not good news.  It’s bad news that induces selling, and it’s selling that makes lows.  Take that bad CPI number back on October 13, the S&P is up 10% since then.  Then there was the day of the Russian invasion back in February when the market opened down big only to recover that afternoon and pretty much never look back.  Many reasons were offered for the remarkable turnaround on the CPI number, but there’s only one that really makes sense – stocks had become sold out.  To put the day in context, the market had fallen the prior six consecutive days.  And for a little more color, consider the dollar volume of option Put buying was triple that of Call buying, by far a record.  If you were buying that many Puts, you’ve likely done a lot of selling.  It’s selling that makes a low, and leaves a vacuum of sorts for prices.

Is gold the new bitcoin?  The much hyped Bitcoin Strategy ETF (BITO-13) is down some 60% this year.  It hasn’t exactly proven a store of value, and this with inflation everywhere you look.  The best inflation hedge has been oil, and the stocks more than the commodity.  Gold has had its moments but despite the long held view to the contrary, hasn’t seemed moved by inflation.  Then, too, it’s hard to fit gold into a convenient theme.  During the great depression a 10% position in Homestake Mining would have hedged the rest of your portfolio, and that period was all about deflation.  Gold shares have stabilized and without question are improved.  Of the 40 or so gold shares we follow most are above their 50-day average, and all of the silver miners are above their 50-day.  The dollar meanwhile is below its 50-day, which should prove a tailwind for the precious metals.

Is China uninvestable?  That’s certainly the thought we had when those stocks opened on Monday, but we’ve been doing this long enough to know when even we have that thought, the worst is likely over.  That’s hard to imagine given what’s going on, but for China this isn’t the first time things have looked more than a little bleak.  Chinese stocks endured a similar bout of selling in March, after which they rallied some 60% over the next few months.  The stocks peaked in June, however, and most stocks traded to new lows.  On Monday nearly 60% of Chinese Internet stocks traded at new lows, the fourth highest in 15 years according to  There have been six other days when more than 55% of the stocks fell to a new low.  Some big losses follow but all showed gains over the next six months.

Three things to keep in mind here – oil, oil and oil.  Then, too, late last week much of healthcare came to life, and there is much of healthcare.  There are the big pharmaceuticals like Eli Lilly (356), the insurance guys like Humana (545), and the wholesalers like Cardinal Health (75).  Finally, there’s aerospace/defense.  When you think about McDonalds (265) and Pepsico (179) punching near all-time highs, you can’t exactly say strength is all that selective – different, but not selective.  Similarly, Deere (395) and Caterpillar (212) were among the leaders Thursday.  While no one was looking they had turned into more than respectable charts.  Meanwhile, the go-to-stocks we all new and used to love, FANG, the Semis and Tech generally, are underperforming, to be kind.  That the market has been able to ignore the action in these stocks seems an important intangible.

So how long can this keep going on?  We are always tempted to say, until you stop asking.  Sounds pretty rude, but they will stop asking when they’re back close to being fully invested.  These end of the year rallies, especially when good ones, can feed on themselves a bit in the form of job security.  If you think you’re not going to buy until the Fed pivots, you look pretty safe.  Suppose, however, the market changes the definition of pivot.  Let’s say rather than easing the pivot just becomes no more tightening.  A drop in inflation to 2% becomes just a peak in inflation.  When markets want go higher they have a way of creating their own reality.  A less esoteric answer to how far this can go is that it will go higher until it does something wrong.  Wrong typically is about those Advance-Decline numbers.  Strength in the Dow without strong participation is how markets get into trouble.

Frank D. Gretz

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US Strategy Weekly: World News

World News

It was a quiet week in terms of domestic economic news, but it was far from dull in terms of global news. In the UK, Rishi Sunak took over as Britain’s 57th prime minister, replacing Liz Truss, whose 45 days in office was the shortest tenure in UK history. Sunak will be the first prime minister of South Asian descent, the first person of color, the first Hindu prime minister, and at 42 years old is the youngest person to hold the office in modern times. He has previously worked for Goldman Sachs, was a managing director of a hedge fund, and might be the richest person to ever hold the office. He formerly served as the Chancellor of the Exchequer (finance minister) in Boris Johnson’s cabinet. Sunak inherits a difficult economic environment, but the market’s first reactions were favorable and British sterling rallied on the news. Separately, the Bank of England is expected to raise interest rates 75 basis points on November 3, one day after the Federal Reserve is expected to raise the fed funds rate by another 75 basis points.

This week Russia took allegations to the UN Security Council implying that Ukraine is preparing to use a “dirty bomb” on its own territory. Western and Ukrainian officials dismissed these charges as misinformation, but many worry that this could be a pretext prior to Putin escalating the war. Simultaneously Putin notified the US of plans to carry out annual exercises of its nuclear forces.  

Over the weekend, the Chinese Communist Party unanimously chose Xi Jinping to be its leader for another term of five years, while also granting him a breadth of institutional power not seen since the days of Mao Zedong. In 2017 Xi removed term limits for the presidency. And in a blatant expression of power, Xi had China’s former president, Hu Jintao, forcibly removed from the final session of the 20th National Congress, a sign that Xi is pushing all but his most loyal allies out of positions of power.

Saudi Arabia’s energy chief Prince Abdulaziz bin Salman blasted the use of emergency oil reserves to manipulate prices in a direct warning to President Biden who just released millions of barrels from strategic petroleum reserves. Saudi’s energy minister stated, “Losing emergency stocks may be painful in the months to come.” President Biden has signed off on historic use of the US Strategic Petroleum Reserve (SPR) this year, releasing 180 million barrels of oil since April, with another release of 14 million barrels this month. This supply has helped to keep a lid on energy inflation in the weeks before the midterm elections, but it is also putting oil markets under pressure with the SPR at its lowest level since 1984. 


At the end of the week, slightly more than half of the S&P 500 component companies will have reported third quarter earnings. This week the S&P consensus EPS estimate for 2022 declined to $206.74 and IBES fell to $222.14 bringing EPS growth rates for 2022 to -0.7% and 6.7%, respectively. These estimates are down from $227.51 and $230, respectively, at the end of April. This means the S&P consensus estimate has declined nearly 10% in the last five months and it is still falling. This week forecasts for 2022 declined 59 cents and for 2023 fell 28 cents. And estimates are apt to fall again this week. Google parent Alphabet (GOOGL.O – $104.48) reported earnings of $1.06 per share versus $1.40 a year earlier, based upon disappointing ad sales. Last week Snap Inc. (SNAP – $9.60) reported its slowest ever revenue growth rate and the stock collapsed. Microsoft (MSFT – $250.66) reported earnings of $2.35 per share in its fiscal year ending in September, versus $2.71 a year earlier, and projected quarterly revenue below Wall Street targets across its business units. Microsoft suffered its worst quarterly net income decline in two years and the weakest revenue growth in more than five years. These results fanned fears of a slump in personal computer sales and slowing growth in its cloud computing business. General Electric Co. (GE – $73.00) trimmed its full-year forecast after reporting a decline in third quarter earnings due to higher raw material costs in its renewable energy business and demand uncertainty due to the expiration of renewable electricity production tax credits. In sum, we expect consensus earnings estimates for the S&P 500 will continue to decline. This fact puts our current 2022 estimate of $209 at risk. We will be reassessing our estimates at the end of third quarter earnings season.

A Bounce

There have already been two bear market rallies that tested the 200-day moving averages in the indices in this bear market cycle, and the recent oversold condition suggests we may be in the midst of a third test. This implies there is room at the top for this rally, but we would keep in mind where resistance could be expected. Key resistance levels are Dow Jones Industrial Average: 32,703; S&P 500 index: 4,126; Nasdaq Composite index: 12,458; and Russell 2000 index: 1891. We are monitoring the Russell 2000 index most closely since it is currently testing key resistance at 1,800. This could prove to be significant this week. Failure to better this level would be a sign that the broader rally is weakening. Remember, the Russell had been a lead indicator of the broad market in 2021 when it failed to move in step with the larger capitalization indices, warning of market weakness ahead. And more recently, October’s decline failed to slip significantly lower than the June low, a subtle sign of outperformance. As long as the Russell 2000 stays between resistance at 1,800 and support at 1,640 the technical trend is neutral. However, a break above 1,800 or below 1.640 could be a trigger for the next intermediate term move. See page 7.

The 25-day up/down volume oscillator is currently neutral with a reading of negative 1.21. However, back on September 30, the oscillator hit an oversold reading of negative 5.6 which was a deeper oversold reading than the negative 5.17 reading seen on July 14, 2022. It was also in oversold territory for 8 of 10 consecutive trading sessions in July and oversold for 18 of the 24 consecutive trading sessions in September/October. This was a longer oversold reading than at the previous low and a sign of intense selling pressure. In short, October’s test of the June lows was unsuccessful by several measures, and the bear market cycle continues. This is true despite the nearly 6% two-day gain seen in the market to open October, the 4% two-day gain seen last week and this week’s 1.6% up day. See page 8.

Our views on the stock market and economy are unchanged. With interest rates apt to move higher, the economy is likely to slow. This suggests a focus on recession resistant stocks and sectors, which means finding companies that can have the most predictable earnings streams in a difficult economic environment. In general, this favors value rather than growth as a strategy. We maintain an overweight status on energy, utilities, staples, and defense-related companies in the industrial sector. Our recommendation on healthcare is a neutral weighting, but we do appreciate its defensive qualities. See page 11.

Gail Dudack

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Stocks continued to fall in the third quarter with September, true to form, once again proving to be the most difficult month of the year. For the quarter, the S&P 500 fell 5.3%, the Dow Jones Industrial Average lost 6.7%, and the NASDAQ dropped 4.1%. The NASDAQ 100 (QQQ), populated with mega-cap growth companies, broke below the key technical level market watchers were eyeing, the June 2022 lows, and may be signaling another leg downward.

The two primary issues facing investors remain the central bank’s efforts to arrest inflation and a deterioration of the corporate earnings outlook. These come as the FOMC remains committed to taking the benchmark interest rate to at least 4.25%, and perhaps higher. With the Conference Board’s leading Economic Index now in contraction for six consecutive months, shipping rates and orders in free fall, commodity prices well off the high and many now at pre-COVID levels, investors are becoming increasingly concerned about both faltering growth and the Fed hiking too aggressively into a recessionary economy. The most recent Chicago PMI, a bellwether for economic activity, came in at 45.7, firmly in contraction and far below economists’ estimates.

On the positive news front, the Atlanta Fed, in a surprise move, upgraded the outlook for the third quarter for the U.S. economy, sharply revising real GDP growth estimates from 0.5% to 2.4%. The main driver for the revision was the strong uptick in personal consumption expenditures. Clearly, the consumer has exhibited some firepower, but it remains to be seen whether this is temporary. With weakening leading economic indicators and a deeply inverted Treasury yield curve, we should remain skeptical.

The Federal Reserve has made it quite clear that fighting inflation is its number one priority and, we think a Fed “pivot” towards easier money is premature. The jobs market remains strong, with initial claims for unemployment at record lows, and hiring consistently above 300,000 per month. As long as jobs remain widely available, it is unlikely the Fed will ease its policy stance on interest rates.

With the twin headwinds of further tightening and earnings estimates falling, it is too early to declare the end of the bear market. We believe, however, we are getting closer to that end rather than the beginning. While high-quality growth companies should remain long-term holdings, our position continues to be that a higher-than-average cash level and allocations to short-term investments is a sound tactical strategy in the current environment.                                                                                                                                  October 2022    

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