Inside Markets — Base Building

A combination of light positioning, low liquidity and extreme bearish equity sentiment has kept the pain trade skewed to the upside as the major indices pushed into technical resistance levels. As of today, the corporate buyback window is open to ~30% of the SPX but we expect the index will still have a difficult time getting through 5650 (upper bound of the 5396-5650 range) level without some further retesting of the lows. Any retest could be confined within the 4/9 bullish outside day between 4965 and 5457 and should hold inside that range in the coming weeks absent incrementally negative trade news and/or a spike in bond yields (10-year above 4.63%).

The recent ~50% retracement in the SPX followed a decent start to Q1 earnings season and ongoing trade deal anticipation. The next few weeks will be defined by weighing the probability of trade de-escalation with the probability of a recession. It is clear to us that the SPX is currently not priced for a recessionary outcome. The average historical peak-to-trough decline in a recession-driven bear market measures ~34%, leaving ~25% downside from current levels. It is hard to know what to do with the near-term macro data given front-loading in the ‘hard data’ and uncertainty-driven downside in the survey data. The wide gap between hard data and survey data could stay in place for another 1-2 months as the negative impact of a trade war takes time to show up in the real economy. The most likely recessionary scenario starts with reduced shipments from China leading to a shortage of goods sometime this summer when empty shelves and higher e-commerce lead to a decline in consumption. In our view, that bearish scenario doesn’t account for goods substitution, structural innovation, and still-underappreciated resilience of the U.S. consumer.