Cloud Hosting

Ken Xuan, CFA, FRM

Head of Data Science Research

[Note: Fundstrat Head of Research Tom Lee was on a well-deserved vacation this week. In his absence, Head of Data Science Ken Xuan and the Fundstrat Team present their views on the week's developments.]

The most important data point over the past two days was Q2 GDP which came in at 2.1% vs 2.2% (expected). This lower than expected report partially caused a risk-on rally with the S&P 500 ending Thursday +0.59%. Still, markets are nervous about looming headline risks, notably a potential government shutdown over the next few weeks. Even though equities rallied the past two days, the equity put/call ratio surged to 1.41 Wednesday, underscoring the "nervousness" in markets. Forward 1M/3M returns are strong when such readings have occurred since 1995, so we see this as more constructive to markets than alarming. Still, the most important factor for markets in the coming months will arguably be the trajectory of inflation.

We believe the latest PCE data support our thesis that inflation remains on a glidepath lower. Although many cite the rise in headline (due to rise in gas prices) as a reason to be "wary" about the PCE release, Chair Powell himself has admitted that the short-term volatility of gasoline will not influence the Fed's actions.

----------

FS Insight Head of Technical Strategy

* Reversal likely could lead to a retest and minor break of lows next week.

* Treasury to Equity correlation remains quite strong.

* September's decline likely could lead to 4Q gains given seasonal tendencies.

----------

Head of Crypto Strategy

* On Thursday, equities and crypto markets rebounded, buoyed by anticipated SEC approval of ETH futures ETFs.

* While an ETH ETF should induce a short-term rally, its intermediate-term impact remains uncertain and will be monitored alongside other indicators (flows). These developments, in the context of a favorable Q4 macro-outlook, enhance the risk/reward profile for Ethereum-based assets like ETHE.

* Amid an upcoming government shutdown that has sped up ETH futures ETF approvals and delayed spot Bitcoin ETF decisions, the odds of a deferral until January for a BTC ETF have risen. However, a Q4 approval for spot Bitcoin ETFs remains our base case.

* Recent shifts in Bitcoin's correlation with macro variables and its outperformance compared to the Nasdaq 100 raise questions about whether crypto is signaling a local or longer-term bottom in asset prices.

* As the typically negative seasonal influences on crypto for August and September wane, we are approaching a period generally considered to be more bullish for crypto markets.

* Core Strategy - Despite soaring rates and volatile asset prices, we believe it's prudent to adopt a more constructive stance on crypto prices as we enter Q4. While we await confirmation from flows data, we think its right to start increasing risk exposure, particularly in the majors and Grayscale trusts, which continue to trade at a discount to NAV. We are reintroducing ETH L2 tokens to the Core Strategy allocation as well as a small allocation to SOL.

----------

FS Insight Washington Policy Strategist

* Speaker McCarthy fails to get Republican Continuing Resolution to keep the government open through the House, with 21 Republicans defying him.

* In the Senate, a bipartisan discussion for a CR continues, but House Republicans will demand immigration and border-protection provisions in exchange for their support.

* House and Senate leaders have told members to stay in DC for the weekend as the Sunday midnight deadline approaches.

----------

* The S&P 500 slipped to 4,288.05 this week, down 0.74%. The Nasdaq was nearly flat, closing at 13,219.32. Bitcoin climbed 2.36% to about 26,868.40.

* Despite high volume of noise, inflation remains the primary macro driver for markets.

* Government shutdown could put the Fed on an automatic "structural pause."

"Sometimes we stare so long at a door that is closing that we see too late the one that is open." ~ Alexander Graham Bell

Markets remain in what Fundstrat Head of Data Science Ken Xuan terms a "vortex of pain." We opened on Monday with markets continuing to digest the previous week's central bank actions (from the Fed, the Bank of England, and the Bank of Japan.)

Last week's FOMC meeting led to renewed fears among many market participants that the Fed would stay "higher for longer." A continued surge in yields followed, weighing on the stock market. Fundstrat's Head of Data Science, Ken Xuan, pointed out that the central bank's quantitative tightening might also have contributed to yields climbing: during the week of September 18, the Fed reduced its balance sheet by $75B -- the largest weekly decline since QT began. Part of this was achieved through a significant selloff in Treasuries, possibly depressing prices and boosting yields.

Regardless of the reason for surging yields, Head of Technical Strategy Mark Newton began his remarks at our weekly huddle by noting that, "The biggest thing you have to understand about the equity market right now is that rates and equities are very inversely correlated and with rates moving up equities do not respond well. We've pushed up to almost 4.75% in the 10-year and so that is certainly a source of concern for the equity market."

From a technical standpoint, however, Newton argued that "there are some reasons to think that these yields are just getting too stretched. So ideally, what's going to happen is that probably as of next week, we see yields start to break, markets bounce, but then yields sort of churn. Then eventually, we peak out between October or November with a larger pullback in rates happening in the next year."

He noted as an aside that, "There are some reasons to think [Treasuries] are pretty good value here. I like (TLT) and (IEF) -- even if you don't catch the exact low, they represent a great value here not only to make money on yield but also in price appreciation."

Returning to the stock market, Newton said that "Since September 1, momentum has turned negative. We are nearly oversold based on a lot of metrics, but we are nearing pretty good support which is right near the 4200 level. I don't think we're going to get down under that. To me, the risk-reward is increasingly good." He summed it up a bit more colorfully: "For those who like to buy and hold your nose, I think you'll be rewarded between now and year end, even if it's not right away."

Although Fundstrat Head of Research Tom Lee was out this week on a much-needed vacation, Xuan and the Fundstrat team assessed the week's data. They also concluded that our constructive base case for the rest of 2023 remains intact.

Data showed apparently conflicting views on the housing market this week. "We saw pretty weak data regarding pending home sales and new home sales this week," Xuan observed. But the July Case-Shiller Home Price Index came in hot at 0.87% versus expectations of 0.70%. This was the first positive reading after four straight negative months.

Xuan and the team found that this higher reading had more to do with the "base effects" of a methodology that excluded weak July 2022 data than with any strengthening of the housing market. We expect the same effect to cause the Case Shiller YoY figure to pivot higher in the next few months, but of the 20 cities that Case-Schiller tracks, eight of them (40%) have housing prices in outright deflation. This is double the 20% average (since 1988), Xuan pointed out, "so in our view, the housing market remains cool."

For stocks, "the battleground remains inflation," Xuan said. As we expected, Core PCE again showed declining inflation. YoY, Core PCE came in below 4% for the first time since 2021, and MoM came in below Street expectations at 0.1%, the lowest that figure has been since November 2020. This provided continued evidence of our assertion that inflation is on a glide path lower.

"Sentiment is actually now more bearish," Newton said. "It's taken almost two and a half months, but we've dropped from very bullish levels in July. Now we're extremely bearish on Fear and Greed. AAII is also now bearish by 13 percentage points."

Xuan also pointed out that hedge funds recently added the most short-exposure, on a week-over-week basis, since the Covid-19 pandemic -- a sign of weakening sentiment. Data from EPFR also shows equities had their largest outflows of 2023 last week.

To us, this bearish sentiment is a bullish sign.

"We're approaching seasonally a much better time," Newton told us. "When you look at the last four Septembers they were all down between 3.5 and 7%. But Q4 is anywhere up between 7% or higher. So we are coming into seasonally a very good time."

Xuan also pointed out that going back to 1950, when the S&P 500 is up >10% through July (as it was this year), but declines from July through September 23 (as it has this year), 4Q performance has always been strong -- eight out of eight times, with any average quarterly return of 7-8%. "That's a stunning 100% win ratio," he observed.

Washington Policy Strategist Tom Block has been writing about the possibility of a federal government shutdown ever since Kevin McCarthy won the role of Speaker of the House in January, and now the shutdown deadline is upon us.

Block collaborated with Ken Xuan and with Fundstrat Research Associate Alexandra Sinsheimer to look at the possible effects the shutdown might have on the market. The results are summarized in our Chart of the Week:

Of the 20 government shutdowns since 1960, the average shutdown lasted nine days, and markets on average were flat during those shutdowns. One month afterwards, markets on average were actually higher by 1.2%. The 1M median performance was +1.3%.

But there was one interesting implication. The Fed has long asserted that its policy decisions would be "data dependent." We contacted the Bureau of Labor Statistics to find out how a shutdown would affect their operations, and we were told in summary that during a shutdown, the BLS suspends data collection, processing, and dissemination. Once funding is restored, the BLS would resume normal operations and notify the public of changes to the economic releases.

Would it make sense for the Fed to make a policy decision with incomplete data? If it was sufficiently long, a government shutdown might automatically put the Fed on a "structural pause."

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

See the rest here:

FS Insight Weekly Roadmap: Q4 Shows Promise After 'Vortex of Pain' - RealMoney