Inside Markets — Rally Exhaustion

The SPX is showing clear evidence of rally exhaustion, but the bullish trend remains intact above ~6350. A break below ~6350 would make us incrementally cautious ahead of key technical support at ~6150.

Wednesday’s PPI and Thursday’s CPI reports will likely be important inputs for markets. Consensus is looking for a headline and core CPI increase of +0.3% MoM each. The risk/reward for equity markets into these prints looks favorable given that cooler-than-expected prints would deliver more expected rate cuts in the forward curve, while hotter numbers are unlikely to stop the Fed from cutting rates on 9/17. In our view, tomorrow’s annual BLS payroll revisions are an underappreciated catalyst with a less-favorable risk/reward as a material decline in T12 job numbers could trigger a flight to safety. Friday’s lower close for the SPX was largely due to monthly revisions with June payroll growth coming in negative for the first time since April ’20. This is noteworthy given that a negative non-farm payroll print tends to precede a recession. The bullish equity outlook during a Fed easing cycle only applies if the economy can avoid a recession.

Labor markets (long lags) are the most important component of the feedback loop that characterizes a lasting recession. Stretched credit conditions and Fed policy tightening have started most recessionary cycles over the last 50 years. Rate hikes that break leveraged consumer spending leads to lower corporate profits, then layoffs and even lower consumer spending. The likelihood of a lasting recession in the current environment seems relatively low, given still-resilient consumer spending (takeaways from last week’s GS retail conference were surprisingly bullish) and strong credit conditions. Easy US financial conditions (USD weakness/wealth effect) are another reason to doubt the likelihood of a recession. Nonetheless, a labor-induced growth scare could still pressure markets in the near term, especially in a seasonally weak September-early October period.