• We are now calling for Fire AND Ice. We have been calling for a mid-cycle correction to happen one of two ways:
• Fire: tightening financial conditions as the Fed signals tapering is coming
• Ice: growth disappointment particularly on the earnings side
• We think it’s increasingly likely these scenarios happen together and we get a >10% correction. The Fed will likely announce its taper plans at its next FOMC meeting just as we expect a disappointment in earnings to materialize.
• Earnings Trouble Ahead. A number of companies have flagged serious supply chain issues in off-cycle earnings reports over the past month. Both forward earnings estimates and price de-rated after many of these reports. We think this will be a pervasive dynamic during 3Q reporting season and expect it to trigger downside in earnings revisions at the index level- a headwind for price. Beyond 3Q, we think the earnings risk comes more from (1) the inability of companies to pass on pricing (2) margin risk related more to higher wages and (3) a reversion (lower) in goods consumption
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I don’t mind admitting I have been perplexed by the relative strength of Wall Street against a background of rising bond yields. The 5-year is trading above 1%, the 10-year hit 1.6% today and the 30-year is also running ahead. Meanwhile CPI at 5.2% is back at levels not seen since 2007.