SUMMARY: The NFIB this morning was consistent with the good and the bad parts of the broader economic backdrop; labor is loosening a bit, and business and sales outlooks are firming up a bit, but the outlook for prices remains a risk. For now, firming expectations support a continuation of the Cyclical rebound that has taken hold over the past two months, and the Deep Cyclical recovery over the past month. In 1Q, Deep Cyclicals were priced for a recession and began recovering in 2Q as nearby recession odds fell. Deep Cyclicals are still trading at a discount to Defensives and Early Cyclicals and should continue recovering near-term.
Despite the improvement in economic data and lower recession odds (HERE) economic uncertainty remains high, and the Fed needs to keep growth below trend to ease inflation. That makes a directional market call, from current levels, difficult and favors internal rotations. The S&P was up +25bps but Deep Cyclicals outperformed. Our destocking reversal baskets (HERE) were up over 1%.
MORE DEEP CYCLICAL INVENTORY SENTIMENT: One reason we have a destock reversal trade on is that inventory sentiment, measured using the Amenity natural language processor, has improved. If we isolate the post-COVID period, when inventory concerns became a much larger issue for companies, inventory sentiment and XRT relative performance have moved together. Management sentiment is an important signal and one that is not likely being tracked/discounted to the same degree as traditional factors or more widespread alternative data.
A pattern similar to XRT has developed in XLI and XLB. Management teams in both industries are much more optimistic about their inventories and equity performance has lagged. Fading inventory headwinds are a support for Deep Cyclicals generally.
John Roque likes Industrials here. Charts on the sector, constituents, and Industrials relative to Tech are highlighted HERE and in the full report below…
MARKET VIEWS: Data overnight was consistent with the overall global economic backdrop. CPI readings in Europe were in-line with expectations, which is good, but still over 6%, highlighting the need for policy rates to stay higher for longer. In the US, the NFIB was a good microcosm of the broader economy; labor is loosening a bit, and the business and sales outlook is firming up a bit, but the outlook for prices remains too high.
For now, that supports a deep Cyclical rebound, because Deep Cyclicals are still priced for worse economic outcomes (PE spreads still below long-term medians). Yesterday’s market action was what we are looking for. The S&P was up only +25bps but Deep Cyclicals outperformed. Our destocking reversal baskets (HERE) were up over 1%.
MORE DEEP CYCLICAL INVENTORY SENTIMENT: One of the reasons we have a destock reversal trade on is that inventory sentiment, measured using the Amenity natural language processor, has improved. If we isolate the post-COVID period, when inventory concerns became a much bigger issue for companies, inventory sentiment and XRT relative performance moved together. Management sentiment is an important signal and one that is not likely being tracked/discounted to the same degree as traditional factors or more widespread alternative data.
A pattern similar to XRT has developed in XLI and XLB. Management teams in both industries are much more optimistic about their inventories and equity performance has lagged. Inventory headwinds fading are a support for Deep Cyclicals generally.
John Roque likes the look of Industrials here. He is flagging (HERE) “The Industrial Sector is the best of the non-Tech Sectors and is trying to break out. It’d be strange to see a breakout for the Industrials while the market / Big 7 pull back, but the Industrials – and the market, too – will get the benefit of the doubt unless this Sector comes under serious pressure. And the Industrials deserve the benefit of the doubt owing to the solid number of BASES among its members.”
John thinks Industrials relative to Tech is interesting here too, consistent with our call. John adds “it’s seductive and tantalizing to think that this Industrials > Tech rally could be starting from the same level as seen in February 2000.”
Source: Bloomberg, 22V Research
