June 5, 2023
Today’s ISM services report fits the disinflation narrative that reemerged in mid-April. Last week’s string of disinflationary May prints point to an intensifying trend that should begin to show up in headline CPI. April headline CPI was +4.9%, but we see that falling to the low 3% range by the July report. Expectations for a surge in T-Bill issuance related to a TGA rebuild have pushed 2-year yields through technical resistance levels near 4.30%. But a headline CPI in the low-3’s should result in lower bond yields across the curve.
CTA positioning in the Nasdaq 100 (NDX) vs. Russell 2000 (RTY) is at a record extreme, and US momentum factor buying during the last two weeks of May was nearly 3 standard deviations above the mean. A market that’s led lower by Tech is one potential pain trade from here. The other is for the market to be led higher by cyclical sectors and small cap stocks. This latter scenario probably requires large scale China stimulus resulting in a strong upward inflection in global manufacturing PMIs. If that were to happen, the cyclical sector to own would be Industrials with metals and mining stocks leading. But meaningful China stimulus seems like a low probability event, the Tech rally has been extreme and we don’t expect the recent strength in cyclical sectors will last.