Inside Markets — Underpriced for Recession Risk

Extreme bearish equity sentiment, light positioning and low liquidity keep the pain trade biased higher in the near-term. Systematic selling pressure has finally subsided, and fund flows are set to improve next week when the corporate buyback window reopens for ~30% of the SPX.

The SPX is testing the lower end of medium-term technical resistance in the 5396-5650 range. The index rejected that level earlier this month and expect it will stay confined below resistance into early summer. From a technical perspective, the SPX remains vulnerable to a retest of the 4835 low during this period with the potential to test longer-term support in the mid-4500s. After a retest, the SPX could form a more durable bottom with a more credible threat to break above 5650.

We’re past the point of maximum trade uncertainty with equity markets now more sensitive to macro data that fits a recessionary outcome. The SPX is underpricing recession risk with the current peak-to-trough decline of ~20% falling short of the historical recession-driven average decline of ~34%. Recessionary cycles usually start with mass layoffs, which leads to reduced consumer spending, lower corporate profits, and more layoffs. The US consumer has a long history of spending until they lose their job. For now, the high frequency labor market data (weekly jobless claims) and high frequency consumer spending data (card spending) signal continued resilience. Card spending data for April is up +3.8% through mid-month vs. +2.7% in March. Anecdotally, COF’s overnight earnings beat included solid consumer credit metrics with reference to healthy job creation, growing real wages and low debt servicing burdens.