Given the sharp recent uptick in interest rates, it’s reasonable to expect some form of US recession next year. Over the next ~6 months, we expect continued resilience based on fading inflation, healthy balance sheets and a lack of macro imbalances offsetting tighter financial conditions.
The mid-October conditions that had us looking for a Q4 rally included technical signals (deep oversold conditions with momentum divergences) that were apparent in all major market inflections over the last 13 years.
The S&P 500 (SPX) is now consolidating gains from the post-CPI rally that took the index through technical resistance at 3900. Once broken, old resistance levels become new support and 3900 should hold as long as 10-year Treasury yields remain below 4%.
Deep oversold internal signals and momentum divergence (daily and weekly) from mid-October had Q4 expectations focused on a potential rally.
If you exclude shelter from last week’s core CPI print, you get a negative MoM core number, which implies deflation.
The S&P 500 has the potential to move higher than we initially expected given the post-CPI adjustment in terminal rate expectations and implied rate cuts 24 months out.
The bearish narrative includes 1) increased inflation expectations; 2) higher energy costs; 3) higher bond yields; 4) higher terminal rates; 5) expected cuts to FY’23 earnings and; 6) geopolitical shocks have been in place since mid-January and is beginning to feel a bit tired in
Implied rate cuts are something to watch alongside changes to Fed terminal rate expectations.
Yesterday’s +5.6% gain in the SPX followed a 27bp decline in terminal rate expectations and sharp increase in expected Fed easing 24 months after terminal rates have been reached.
SPX rally follows a cooler than expected CPI print. Consumer Discretionary, REITS and Tech are outperforming, while defensive groups like Health Care and Staples lag but still post solid gains.
