July 6, 2023
Today’s advance in 2-year yields drives the risk free rate beyond the earnings yield on the SPX. Using Bloomberg consensus estimates, the forward earnings yield on the S&P 500 is 4.99% vs. a two-year risk free Treasury that currently yields 5.08%.
The S&P 500 has rallied ~10% since late April on a coincident improvement in market liquidity. Expectations now are for liquidity to shift from being a tailwind to a headwind in the coming weeks with the TGA rebuild as the major catalyst.
Positioning and sentiment are no longer supportive for equity markets. Net overall positioning has moved into the 80th percentile, and AAII bullish sentiment is now at elevated levels. The bull-bear spread was -33.2 in late March and is now +22.35.
The recent two-month long rally in the SPX occurred despite rising interest rates. Two year Treasury yields are up 25bp and terminal rate expectations have risen by 40bp. Over the last two months, the performance of the SPX uncoupled from interest rates, which were the single most dominant factor since late 2021. The deeply inverted yield curve is pointing to a recession. US consumer excess savings have declined from a peak of $2.1T in 2021 to less than $500B today. At the current pace of spending, the excess savings should be depleted sometime in October, and recessions usually start with the consumer. The Fed thinks that any recession stemming from the tightening cycle will be mild. Investors may ‘look through’ a mild or short recession.