Inside Markets — Macro Backdrop

Assuming the debt ceiling agreement is passed this week simply means that market attention will shift back to the challenging macro backdrop. US inflation data remains elevated, global manufacturing PMIs are in contraction and China activity data is rolling over.  A disappointing China reopening should also result in a period of European equity underperformance.

The SPX continues to probe the upper end technical resistance near 4200.  Narrow leadership and crowding into the largest market cap stocks continues after the triggering of momentum divergence sell signals early last week. The outperformance of large stocks vs. SMID cap stocks is a defensive, flight to quality dynamic that often precedes a flight to cash. During the late April pullback, we cited an increased likelihood for the S&P 500 to hold above technical support, which would allow time for more crowding in mega-cap stocks. This is exactly what’s happened over the last month with the relative outperformance of mega-cap stocks reaching a 25-year high last week. A sustained break above 4200 with unchanged internal conditions wouldn’t change our tactically bearish outlook. The decelerating advance has been led by Tech and a handful of Comm Services stocks. A sustained break above 4200 with broad participation led by commodities and deep cyclical sectors would definitely change our outlook. The likelihood of that happening when policy rates are 2x higher than the neutral rate seems very low. A cyclical recovery becomes possible once the Fed decides to pivot. And that doesn’t seem likely until we see material weakness in the jobs market and material downside in asset values. The earliest clues of a weakening jobs market usually follows two consecutive weeks of jobless claims exceeding 260,000.  Monetary tightening operates with a long lag and the onset of recession seems to happen in an instant.  For the SPX specifically, we expect increased jobless claims will lead to a retest of October lows near 3550.