Inside Markets — Performance Anxiety

The SPX is now overbought with signs that higher prices are driving performance anxiety as sidelined investors are ‘forced’ into equities. These investors are generally considered weak handed, reluctant buyers who sell newly acquired positions at the first sign of trouble. The dislocation and subsequent unwinding of these positions often results in higher realized equity volatility.

Higher realized volatility remains the single biggest threat to equity valuation multiples that sit near the upper end of the historic range. Volatility as measured by the CBOE Volatility Index (VIX) has been at subdued levels (under 20) since late October. Prolonged periods of subdued volatility always result in multiple expansion and elevated volatility always leads to multiple compression. The VIX index currently sits at an equity friendly 12.5 with levels north of 20 becoming a headwind for rally attempts. VIX levels north of 30 often takes months to unwind.

Better-than-expected Q1 results and forward guidance have resulted in a slightly higher year-ahead SPX consensus EPS estimate of ~$276. The slightly higher EPS estimate takes the forward multiple from ~21x down to 19.2x. Note that 21x is at the upper end of the historic range that tends to top out at 22x. Of course, the estimate is not without risk. If SPX companies are able to meet Q2 guidance, Q3 and Q4 numbers will still need to be 15% higher than what was reported in Q1 to make the estimate a reality. And strong sequential EPS growth will be more challenging if the recent string of softer activity data continues.

Equity markets are trading like the reacceleration in Q1’24 inflation has reversed. One month’s worth of data isn’t a trend, but the slightly cooler April report was encouraging in that it was accomplished without a material decline in shelter prices. Running alongside the cooler April CPI number has been two weeks of weaker-than-expected growth data. At the moment, the weaker growth data is contributing to the bullish inflation narrative without fueling growth concerns. Keep an eye on this.

Thursday’s flash PMI data for May will further inform the growth outlook with expectations for manufacturing to slip into contraction at 49.9, down from 50 and for services to improve to 51.4 from 51.3. Wednesday’s NVDA earnings report will also be key to the growth outlook and the next major inflation print will be April core PCE due on May 31.