June 21, 2023
Markets are waiting for a traditional recession or soft landing to follow the Fed’s tightening cycle, but there may be a third template that fits better. Yesterday’s strong housing starts data opens the door to what might become an unsynchronized recession scenario. Homebuilders, Tech and semis may have already experienced their recession in 2022 and now recovering, while other groups fade.
The reversal in the US Economic Surprise Index (ESI) that occurred in late May resulted in cyclical sector leadership as PM’s closed out underweight positions. The US ESI had spent the prior three months in a steady downtrend. The March-May slide in the ESI resulted in narrow market breadth and thin leadership that often precedes a correction or worse. We returned to those market internals over the last five sessions until yesterday’s improved housing data pushed the US ESI back above its 100-day moving average. The uptick in the ESI results in resumed cyclical sector leadership this morning. Cyclical sector performance has a strong positive correlation with the ESI over short periods of time. Long periods of cyclical sector leadership precede cyclical recoveries, which are dependent on monetary policy accommodation and expanding money supply. Those conditions may exist in the near future but not today. The next test for an unlikely cyclical recovery comes on Friday morning when flash PMIs are released.
Bond yields peaked last October and we expect the recent advance will run out of gas in the weeks ahead. The 5-year note currently yields 4% with strong resistance in the 4.13-4.19% range. The 10-year note has a similar profile with resistance near 3.90%, while the 30-year bond yield could push to 4% before reverting lower.