Downside Volume

We believe it is likely that equities are on the verge of establishing a new low. The good news is this may be an important part of a defining low in this bear market. The main reason for our near-term concern is the action of our NYSE 25-day up/down volume oscillator. The 25-day up/down volume oscillator declined to negative 3.7 this week, recording its third oversold day in the last five trading sessions. The decline was sudden and the pattern in the oscillator suggests downside volume is gaining momentum. In fact, the July 6 reading of minus 4.09 was the most oversold reading recorded since April 1, 2020. And though some might think that an oversold reading is positive, we would point out that in March and April of 2020, the market dropped to oversold and remained in oversold territory for 25 of 28 consecutive trading sessions. See page 12. Sometimes negative momentum begets more negative momentum.


This acceleration in downside volume is coming just ahead of the releases of June CPI and PPI data. And it may reflect the concern investors now have regarding inflation. Unfortunately, we believe the consensus may be disappointed in the results. To be specific, the May headline CPI release showed prices rising 8.5% YOY, the highest pace in 40 years. See page 9. What we believe is important is that if the CPI were to remain unchanged in June, the pace of inflation would still remain high at 7.6% YOY. However, an unchanged CPI seems unlikely since even at the lower prices for WTI crude oil (CLc1 – $95.84) seen currently, WTI is up 29% YOY.

And as previously noted, housing represents 42% of the CPI’s weighting and housing rose 6.9% YOY in May. The median price of an existing single-family home rose nearly 15% YOY in May, and while 15% YOY is down from a peak rate of 26% YOY a year earlier, housing will still add to inflationary pressure. Meanwhile, rents, which represent nearly 24% of the CPI weighting, tend to follow the trend in home prices, but with a sizable lag. Given this backdrop, it is difficult to see inflation falling much in June. We have also pointed out that medical care prices have been offsetting some of the larger increases seen in transportation costs. Medical care rose a “modest” 3.7% in May, but health insurance pricing is seasonal, and we expect medical insurance, and the medical care segment of the CPI, will add to inflation in coming months.

The PPI represents the pricing pressure in the pipeline that will eventually shift to consumer prices. The PPI for final demand rose 10.7% YOY in May. If prices were unchanged in June, the year-over-year pace only falls to 9.8%. In short, there is some simple math behind the CPI and PPI data that suggests the June inflation data will not soothe investors’ nerves.

Earnings Season

Moreover, second quarter earnings season begins in earnest this week, and this could be a market moving event. A number of brokerage houses are bringing their 2022 earnings estimate for the S&P 500 index down to our $220 forecast and that is a plus. But as we noted in our March 9, 2022 (“A Bear is a Bear is a Bear”) “higher commodity costs are likely to pressure profit margins and lower revenues for many companies and could make our $220 earnings estimate too optimistic.” We still believe this is true. Our $220 estimate represents a 5.7% YOY increase from 2021, and we feel it is conservative considering that earnings for the energy sector are expected to increase between 120% YOY (IBES) and 137% YOY (S&P Dow Jones) this year. Excluding the energy and perhaps the materials sectors, we expect earnings will decline in 2022. In a week or so, investors will have a better idea of second quarter earnings results.

PepsiCo, Inc. (PEP – $169.50) released earnings results this week and its second quarter core earnings rose 8.1% YOY, but reported earnings fell 39.4% YOY due to a write-off related to the Russia-Ukraine conflict. A key takeaway from the company’s earnings call was that it planned price increases and cost management. A main part of our strategy for 2022 is to focus on companies and sectors that will be most immune to both inflation and recession. This includes necessities like food, staples, energy, utilities, and we also include the defense-related industrial stocks given the increase in funding of national defense by Western countries as a result of the Russian invasion of Ukraine.

Worrisome Economic Data

The June jobs report indicated an increase of 372,000 jobs and an unchanged unemployment rate of 3.6%. However, total employment in the US is yet to exceed its previous peak which is unusual for an expansion that is now over two years old. We think this is a weakness in the employment data that most economists have overlooked. See page 3. And employment gains have been a story of the haves and have-nots. Unemployment for those with less than a high school degree has risen in the last four months from 4.3% to 5.8%. Economists may be disregarding this factor since this segment represents only 6.4% of the workforce. However, the only group that has made significant gains in employment in the last two years has been those with a bachelor’s degree or higher, which represents 43% of the working public. The remaining 47% have not seen the same gains. See page 4.

Both the manufacturing and nonmanufacturing ISM indices fell in June, and were down 13% YOY and 9% YOY, respectively. However, take note that both surveys show their employment indices falling below the 50 neutral level, indicating a decline in employment. This could be a leading indicator for the BLS employment data. See page 5.

In June, the NFIB small business optimism index fell to 89.5, its lowest reading since the 88.8 seen in January 2013. The outlook for the next six months fell to negative 61, the lowest reading on record. All ten components fell in June, including plans to expand business, to increase capital expenditures, to increase employment, or to add to inventories. The only positive seen in June’s survey was that 50% of owners indicated they had unfilled job openings. See page 6.

A number of markets are trading as if a recession is approaching. As previously mentioned, the price of crude oil has collapsed from a high of $122.11 in early June to $95.84, this week. This appears to be due to a fear of a global recession. Nevertheless, oil is still up 29% from July 2021. Also falling is the 10-year Treasury note yield which had reached a high of 3.48% in June, before dropping to 2.95% this week. This decline is not a good sign since the Treasury yield curve is now inverted from the one-year note yield to the 10-year note yield. Keep in mind that the Fed expects to raise the fed funds rate to 3.5% or higher which would invert the entire yield curve in a classic sign of a recession. See page 7. Valuation can be deceiving when not put into perspective. The current trailing PE of 17.7 X looks low, relative to the 50-year and post-1947 averages, but the PE will rise if EPS forecasts are too high. Plus, the impact of inflation is best seen in the charts on page 9. When inflation moved above average (3.5% YOY) in the 1972-1982 period, PE multiples fell to single-digits and below the standard deviation range. Another way of measuring inflation is the Rule of 23, which sums inflation and PE multiples. The market has traded above 23 for the last two years and the sum is currently 24.8. Unfortunately, based on this historical benchmark, the market remains expensive. See page 9.

Gail Dudack

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PLEASE NOTE: Unless otherwise stated, the firm and any affiliated person or entity 1) either does not own any, or owns less than 1%, of the outstanding shares of any public company mentioned, 2) does not receive, and has not within the past 12 months received, investment banking compensation or other compensation from any public company mentioned, and 3) does not expect within the next three months to receive investment banking compensation or other compensation from any public company mentioned. The firm does not currently make markets in any public securities.

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