Revisionist History

As our battered stock market stumbles into another week, the earnings confession season is upon us. Target, the once unassailable master of retail management, is cutting its forecast for the second time in as many months, seemingly caught unaware of the shift in buyer behaviour. It could be the start of a trend.

Consumers, their finances squeezed from lagging wage growth and higher food and energy costs, are paring back their spending. As retailers are now reporting, the sudden spike in the inventory to sales ratio has caught them napping. And soaring transportation and labour costs combined with consumer retrenchment are finally trickling through to margins. Analysts, who have been blithely predicting a flat earnings outlook, are now starting to squirm. Downward revisions are coming!

There has been a slow downward drift in the breadth of estimates for the S&P 500 but given the recent news analysts will soon give up on their pollyanna scenarios. The hope for a soft landing seems increasingly fleeting given the sudden deterioration in the once inviolate U.S consumer. A recession usually begins before the market even realizes it.

S&P 500 Earnings Revision Breadth

On the good news front, unemployment is set to stay structurally low and, despite the pain at the pump and in the grocery cart, the consumer is still able to cope. Income security is being helped by a shortage of labour and stronger participation rates. So it's more of a profits recession, centred on corporate income statements and not on individual bank accounts. This would argue for a growth slowdown in the aggregate, not a full-blown recession. Either way, markets will find it difficult to sustain any kind of rally with the profit headwinds 'blowing a gale'.

So other than consumer discretionary companies, are there other sources of downside? Microsoft has signalled it sees corporate spending weakness after it announced its intention to slow hiring. The stock has acted poorly during the recent bounce. The microchip companies have all lowered their outlook due to global weakness. Lumber prices have cracked, reflecting a sharp slowdown in housing due to the affordability squeeze.

In the consumer space, only air travel has seen an upward lift in its forecast. The summer travel surge for 2022 is being artificially inflated by the last pent-up demand from the Covid shock. I'm guessing that by the end of this year, that effect fizzles out once the family reunions have happened. Corporate travel will take years to fully recover as long as Zoom exists as an alternative, especially since airfares have just doubled. The fact that the stocks are still in a downtrend says it all.

Airline ETF

So it is left to energy to offer an alternative to the profit revision minefield that is the other 95% of the S&P 500. But the allocation of most portfolios to the politically incorrect segment of the market is minimal and they all seem stretched on the charts. Most investors own more Apple and Microsoft than all the energy ESG pariahs combined.

There are some remaining known unknowns. Where are food and energy prices headed over the next six months? Is China's reversal of the shutdown strategy enough to propel its economy? Is the U.S. Treasury market able to withstand the supply shock of QT? Will a Canadian team ever win the Stanley Cup again?

Who is to say?

I could make a guess, but it would only have to be revised anyway.

Risk Model: 5/5 - Risk On

Notionally the model is flashing a buy signal for risk but I, for one, don't buy it. The depressed levels of AAII sentiment will take more work than just one bear market bounce to convince me that investors are ready to re-engage with the market.

As for the volatility gauge, we also require a more convincing reversal than we have seen given the still upward sloping price pattern.

The copper market has already started to retreat from the short covering that was prompted by the China shutdown reversals.

The negative trendlines are still in place for all three.

AAII Sentiment Ratio: Bull/Bear

3 Mo CBOE Volatility

Copper/Gold Ratio