October 20, 2023
The media cites the backup in bond yields and geopolitical tensions as primary drivers behind today’s pullback, but disappointing overnight earnings should also make the list. Aggregate management commentary builds a narrative around an economy that’s strong today but decelerating. Yesterday’s incrementally dovish comments from Powell also fit that narrative.
The backup in bond yields became dislocated from their fundamental drivers about three weeks ago. Yesterday, Powell characterized the recent backup in yields as ‘a pure tightening of financial condition,’ which is code for ‘term premium.’ Term premium is the additional compensation that investors require for unknown risks associated with holding longer-term debt. We think most of that unknown risk comes from high and rising US fiscal deficits, which could keep upward pressure on yields until its addressed.
We keep our bearish tactical outlook on the S&P 500 (SPX) based on the recent breakdown in cyclical indices and concerns that elevated bond market volatility could spill into equity markets. All cyclical indices have broken technical support following months-long bearish distribution patterns. Weakness in cyclical groups have translated into further crowding in mega-cap Tech stocks. Crowding in the largest stocks by market cap is a defensive dynamic that occurs at the end of a bullish cycle. Note that narrow market breadth was a primary reason behind our tactically bearish outlook in late-January 2020. Markets move ahead of events and the breakdown in cyclical indices is an early warning signal. The NYSE FANG+ Index (NYFANG) is the mega-cap proxy with a sustained close below 7175 (-3.2% below current levels) leading to increased downside momentum. The CBOE Volatility Index (VIX) has risen from its mid-September low of 12.8 to 20.71 with levels above 22 acting as a headwind for rally attempts and a spike above 30 taking several months to unwind. Technical support for the S&P 500 (SPX) sits at the bullish inflection near 4200. Sustained closing levels below 4200 would add conviction to our tactically bearish call.