June 13, 2023
Widening market breadth beginning in late May removes a key technical concern for the sustainability for the rally. Participation from cyclical sectors and small cap stocks followed a sudden uptick in the US Economic Surprise Index (ESI) beginning on May 25. The uptick took the US ESI through its 50, 100 and 200-day moving averages, convincing portfolio managers to close out cyclical sector underweights. Cyclical sector leadership and participation from small cap stocks are important factors in maintaining a near-term bullish outlook. The US ESI has calmed down a bit over the past week, but the rotation is getting a second wind from China stimulus headlines. Energy and Materials led the S&P 500 higher today after the PBOC unexpectedly cut its 7-day repo rate and later cut its Standard Lending Facility (SLF) in what looks like the first in a series of rate cuts. China 10-year bond yields fell 6bp to 2.62% on the announcement. Reports also suggest that Beijing is considering a broad package of stimulus measures. But China’s stimulus efforts will need to be far more significant in the weeks ahead given stagnant wage growth, weak consumer confidence and low excess savings. Financials are the third deep cyclical sector that are shrugging off yesterday’s NII warnings on better-than-feared bank updates this morning.
Near-term outperformance in Energy and Materials will depend on further China stimulus, while Financials face extremely challenging business conditions. At some point, the outperformance of these sectors will depend on US stimulus efforts. And tomorrow’s Fed meeting is unlikely to provide markets with any assurances of that happening for the foreseeable future.