February 8, 2024
The SPX rally decelerates on the approach to 5000 with narrow leadership and early signs of bearish momentum divergence. Sell-side equity baskets that measure crowding also look extended and match levels from last July that kicked off an ~11% peak-to-trough decline in the Nasdaq 100 (NDX). The equity baskets that measured the crowding in July declined an average of ~17% over the same period. Narrow leadership and crowding in the largest stocks by market cap is a defensive dynamic that often occurs in a maturing late-cycle environment.
The 5000 level is only psychological resistance as round numbers like this tend to make headlines. Technical resistance is actually higher in the 5095-5215 range and a break below 4800 would confirm a short-term trend reversal.
Valuation: The 20.5x forward multiple on the SPX is the product of a benign macro environment of declining inflation and resilient growth. The multiple will compress when macro uncertainty drives increased levels of equity volatility. In the current environment, the most likely sources of macro uncertainty would relate to the timing of Fed rate cuts or a reacceleration of inflation. Tuesday’s release of January CPI is the next major catalyst after an unusual spike in the prices paid components of manufacturing and services ISM.
We expect a June Fed rate cut if the annualized rate of core PCE meets our forecast of 2.2% by May. There’s no shortage of data on what happens to equities after the first Fed rate cut. Equity markets tend to decline after the Fed cuts rates when the easing is the result of a growth scare or weaker growth. Equity markets tend to rise after the first cut when it’s the result of inflation normalization. The second scenario is the right path for right now, but that can change. Markets with crowded positioning are always at risk of de-grossing with rising levels of realized equity volatility as your early warning signal. Absolute VIX levels >20 (now 12), flattening VIX futures curve (now adequately steep) and/or SPX break below 4800 would change our outlook.