April 5, 2023
Bond prices and equity prices have been positively correlated for the last 14 months. Over the long run, these two asset classes have a negative correlation with higher bond prices and lower yields reflecting increased risk of slowdown in economic growth. Slower economic growth usually translates into lower corporate earnings, which explains the negative long-term correlation between the two asset classes. This week’s string of US data disappointments may have reset the cross market relationship with today’s lower bond yields failing to cushion equity markets. In our opinion, a return to the normal historical relationship is prerequisite for a cyclical recovery as a ‘bad news is bad’ phase adds to the economic pain and encourages the Fed to ease policy. Simply put, higher asset values are dependent on policy accommodation and expanding money supply. The S&P 500 (SPX) is down ~10% and the NASDAQ 100 (NDX) is down ~14% over 14 months of restrictive monetary policy and slowing money supply growth.
The SPX has rallied to the upper end of a multi-quarter trading range in the mid-4100s and showing signs of reversing. From a purely technical standpoint, we expect the rally to fade from the current range with accelerated downside at levels below 3900. From a fundamental standpoint, a stubbornly restrictive Fed amid an already challenging backdrop could result in more systemic stress and accelerated downside to test last year’s low near 3550.