Inside Markets — Vulnerable SPX

US equities are mixed and off best levels with the S&P 500 (SPX) attempting its 32nd record close for the year, though narrow leadership makes the current bull market highly vulnerable. Last week’s May CPI/PPI prints seemed to confirm a disinflation theme that emerged at the beginning of Q2 in pockets of the equity market, specifically consumer discretionary stocks. In early/mid-April, we began to hear from travel (airlines/cruise ships) companies that they were running out of pricing power. The theme quickly spread to other discretionary parts of the market like quick service restaurants (QSRs) and even luxury goods. The broader equity market response has been a rotation to the highest quality secular growth stocks that still have a lot of pricing power – think NVDA and AVGO for example. The rotation comes at the expense of most cyclical pockets of the market where you see deceleration. The SPX has made 31 consecutive all-time record highs because it’s a market cap weighted index that is overweight tech. The 31 record highs have not been matched/confirmed by new highs in cyclical sectors like Financials, Materials or Industrials. The record highs in the SPX haven’t been confirmed by foreign markets like the NKY, SX5E or HIS. This is a very narrow rally in high quality, defensive growth at the expense of cyclical growth. Basically, the equity market is taking down its estimates on growth and inflation. A bull market characterized by narrow market breadth is not sustainable and leadership from defensive secular growth at the expense of cyclical stocks isn’t a bullish signal. The SPX is now vulnerable if something in tech (defensive secular growth) doesn’t meet expectations. Market breadth can improve but that needs to happen soon.

The rotation out of cyclical stocks and into secular growth/defensive stocks will likely continue until there’s a spike in realized equity volatility. Equity volatility as measured by the CBOE Volatility Index (VIX) has remained in ‘subdued’ territory (below 20) since late October. All markets discount future events and the late-October decline in the VIX preceded benign macro conditions by several weeks. A rising VIX will likely precede uncertain economic conditions by several days/weeks. VIX levels north of 20 become a headwind for market rallies and levels above 30 usually take months to unwind.