Sideways stock market is making traders crazy, but the pain trade is still up

Published Wed, May 17 20239:04 AM EDT

The consumer is still holding up, but definitely not as confident as a few months ago. Target was good and bad. Comp sales were flat, lighter than the 1% expected. On the positive side: Traffic was higher, which is good. Second quarter guidance is light, but guidance is unchanged for the year. That sounds good, but you could drive a truck through the $7.75-$8.75 full-year earnings estimate. Target could have thrown the bulls a bone and raised the low end of the guidance, but chose not to. Traffic is up, but they don't change guidance? That tells me that business is choppy and management doesn't have a lot of confidence the discretionary part of the business is going to bounce back. Bottom line: with Home Depot missing on revenues and lowering full year guidance, and Target not having confidence in the back half of the year, this tells me that the consumer is definitely more cautious than a few months ago. The good news: Target is a survivor and will survive. It is a well-run retailer with huge scale and a strong balance sheet. The bad news: the customer base seems to vacillate. When the lower end consumer has money, they buy more discretionary items at Target. When they don't, they seem to go to Walmart. Trading trends: ready for summer Ready to give up and head for the shore for the summer yet? I know, it's early, but call around on trading desks, or walk around on the equities or options floor at the NYSE, and it kind of feels like everyone is eager to get the summer going, mostly due to the lack of action. And lack of volume. And lack of volatility. And lack of trend. Traders are "not sure they should be leaning into, or out of, the market," Craig Johnson at PiperSandler tells me. Here's the good news: the market has absorbed a lot of bad news, but it has been essentially sideways (4,100 range) for the entire second quarter. Think about that. Bank collapses, the war in Ukraine, the debt ceiling negotiations, along with continuing hikes in interest rates...and the market is flat? Put that information to a trader a year ago, and most would have guessed the market would be 10%-20% lower. Earnings not cooperating with 'imminent recession' story Even more startling is the state of earnings. Six months ago, everyone was convinced earnings would fall off a cliff in 2023. Most Wall Street strategists thought earnings this year would come in at around $200, which would be a 10% drop from the $218 that was printed in 2022. That would be entirely normal for a recession, which usually see earnings drop 10%-20%. Except it hasn't happened. Earnings estimates for the first quarter were cut too much. Expected to be down 5.1% on April 1, first quarter estimates have been rising for weeks and are now expected to be down only 0.6%. Estimates for the second half of the year have been steady. Full year earnings for the S & P 500 are expected to grow 1.2%, unchanged from the start of the quarter. What kind of recession are we going to have? Here's the bad news: the stock market can't seem to agree on what kind of slowdown we might have. Parts of the market (growth stocks like technology, defensive sectors like healthcare and consumer staples) are looking right through any slowdown. Others (cyclicals like industrials, materials and energy) are behaving like a slowdown is definitely coming. Caterpillar, for example, often looked on as a bellwether for international growth, is 20% below its recent high in January. More bad news: the bond market, with an inverted yield curve, seems to be signaling a more serious recession is coming as well. The pain trade is up In a confusing tape, perhaps the most important thing to realize is how sour everyone is. Sentiment is very negative. And that is a positive. The American Association of Individual Investors sentiment survey has seen investors who are "pessimistic" in the 35%-45% range for weeks, far above the historic norm. The BofA Global Fund Manager Survey has been extremely pessimistic most of this year. The Commitment of Traders report, which looks at open interest in the S & P 500 E-Mini futures, has indicated very high short interest by non-commercial (retail, hedge funds) traders for weeks. We are talking about very high levels. "Some of the highest short interest we have seen since 2007," PiperSandler's Johnson tells me. "The traders have baked in a very negative outlook." This, as we have noted many times, is a contrarian indicator. In the past, during periods when short interest was as elevated as this (2007, 2011, 2015 and 2020), the market was typically higher three months later. How much higher? About 4.8% higher, Johnson tells me. "When we have had high short positions like this in the past, we often see the markets move higher," he told me. One of the favorite indicators traders like to use is the "pain trade." What move in the market would cause the most discomfort for the most traders? With sentiment so negative, it's clear what would cause the greatest pain. "The pain trade is up," Johnson, a chief market technician, tells me. "Everyone is negatively positioned; the real risk is they get caught offsides and the market moves higher."