October 17, 2023
A resumption in the yield backup follows a hotter-than-expected September retail sales number. Retail sales are quoted in nominal terms, which makes the report an indirect measure of inflation and just the latest hotter-than-expected September report after Jobs, PPI and CPI. The October NAHB builder confidence index reached its lowest level since January. Details of yesterday’s Empire Fed report point to ongoing risks for corporate margins as prices paid held steady at 25.5, while prices received fell -8 points to 11.7.
Our tactically bearish outlook for the S&P 500 (SPX) is partially based on mid-September technical breakdowns in cyclically-sensitive indices like the Russell 2000 (RTY), equal-weight S&P 500 (SPW) and EuroStoxx 50 (SX5E). These cyclical indices are outperforming the SPX today after the retail sales beat and leadership vacuum (AI chip and GLP-1 weakness) drive a near-term mean reversion trade only. More durable cyclical leadership like we saw in early June would likely follow an upside breakout in the US Economic Surprise Index (ESI). The US ESI now stands at 55.5 with levels above 65 qualifying as a breakout. The RTY, SPW and SX5E would also need to take out their highs from July in order to change the intermediate-term bearish outlook for the broader market. We see greater near-term probability for rising bond market volatility to spill into equity markets, resulting in a SPX break below 4200.
All bond yield tenors are moving to cycle highs with closing levels key to the near-term outlook. The near-term equity narrative is embracing the advance because it means the Fed can remain on hold as the backup in yields ‘does the Fed’s work.’ The Fed is in control of interest rates and can only influence longer-dated yields through policy. Allowing bond yields to do the work of the Fed has the potential to end badly with upward pressure on long-term yields coming from unfavorable near-term supply/demand dynamics.