Inside Markets — US Equity Narrative

The US equity narrative may be starting to evolve with increased concern for the growth outlook. Yesterday’s weaker-than-expected ISM manufacturing print of 48.7 vs. consensus for 49.5 helped feed the evolving narrative. One thing to consider is that ISM manufacturing has been in contraction (below 50) since October ’22 and the US economy still managed to grow above trend in the 18 months that followed. Dispersion indices like the ISM and PMI have lost some of their predictive power in the wake of the pandemic, but tomorrow’s ISM services print will still be closely followed. Friday’s Jobs Report is the more important input for markets, given that the path to Fed rate cuts still runs through weakening labor market conditions.

Emerging concerns around slowing growth can be seen in US bond yields. Ten-year Treasury yields closed below 4.475% support and are now extending below the 200-day moving average at ~4.35%. There’s very little technical ambiguity in the four-day pullback in yields as each day has closed at/near lowest levels. Closing levels are all that really matter with a sustained break below 4.35% confirming the near-term peak of 4.61%. The pullback in yields is not only due to softer data as the Fed’s slower QT pace also starts this month. We’re still in the ‘bad news is good phase’ where lower yields receive a favorable equity market response, but this dynamic quickly evaporates when labor markets weaken and/or earnings estimate revisions turn negative. Consensus is looking for May non-farm payrolls of +180,000 vs. April’s +175,000. The number will likely need to fall below +50,000-75,000 to get a bearish equity market response.

We’re seeing some gentle de-risking in equity markets as investors wait to see if this week’s macro data further support a slowdown/recession narrative. We’ve seen a number of false recessionary signals over the past ~18 months, which makes forecasting such an occurrence less popular. But price action during Q1 earnings season where earnings beats were barely acknowledged and misses were severely punished makes it more important to remain on watch. The Q1 earnings season dynamic could have just been a function of buyer exhaustion, but the recent narrowing in market breadth and defensive sector leadership makes it more difficult to ignore. In addition to bond yields and data, keep an eye on liquidity conditions with the Fed’s Reverse Repo facility on the decline with a balance of just $377B as of yesterday. From a technical perspective only, you’d need to see the SPX break below the 5060-5140 level to ‘knock out’ the April/May bullish rebound. And break below ~5000 opens the door to corrective price action down to ~4600.