March 8, 2023
Multiple factors combine to create a challenging outlook for equities. Yesterday’s testimony from Fed Chair Powell triggered a ~1.5% sell off in the S&P 500 (SPX) and further yield curve inversion. The 5/10-year curve inversion took a big step in the wrong direction from an equity perspective as it slipped to a new cycle low of -35bp. The 5/10 curve inversion made a bottom near -30bp during every tightening cycle with the exception of the 1975-1981 period. An ultimate bottom in the 5/10 curve inversion from every tightening cycle preceded a bottom in equity markets by 1-5 months. An apparent bottom in the 5/10 curve inversion last September was a pretext for our bullish Q4 outlook in early October. Unfortunately, yesterday’s deeper inversion implies a longer tightening cycle and a lower outlook for the S&P 500.
Macro fundamentals remain challenging for equity markets after a year-long yield curve inversion and policy rate that’s 2x higher than neutral. Nominal bond yields are well above inflation expectations and US money supply is contracting. Micro fundamentals are equally challenging with a rapidly rising cost of capital following three quarters of margin compression for the SPX.
The SPX continues to hover just above key systematic triggers in the mid-3900s. These include obvious triggers like simple moving averages used by CTAs and less-obvious momentum triggers used by trend following strategies. Closing levels below 3940 would likely result in increased selling volume and an opportunity to test first level technical support near 3765.
The price of copper is often used as a proxy for global growth 2-3 months forward. Copper’s sharp rally in January followed China reopening headlines, which also formed the basis for an emerging bullish equity narrative. Recent weakness in copper prices may imply growing impatience with China’s reopening and its contribution to improved global growth. Copper is rebounding today but very close to breaking near-term technical support. Increased weakness in copper would generate deeper concern for the global economy and remove the most compelling support for the bullish equity narrative.