October 2, 2023
Manufacturing ISM for September was a net positive with stronger growth and weaker inflation readthroughs. The headline number increased 1.4 MoM to 49 on improved new orders, while the prices paid component fell -4.6 points to 42.8. Services ISM is due this Wednesday, but market participants are far more interested in weekly jobs figures, including the August JOLTs report tomorrow and the September Jobs Report on Friday. Next week brings the September CPI print on Thursday and the start of CQ3 earnings season on Friday.
Bond markets ignore the downtick in the prices paid component of ISM and sell off as the higher headline number increases risk of higher-for-longer rates. US equity markets will struggle to advance as rising bond yields threaten valuation multiples, present a near-term drag on growth and increase the risk of dislocation in funding markets. The three-month long rise in bond yields hasn’t come from fundamental sources as inflation breakeven yields remain little changed over the period. Increased Treasury issuance is playing a factor, but the recent backup seems primarily based on a tendency for 10-year yields to converge with terminal Fed rate expectations at the end of a hiking cycle. If this dynamic continues in the near term, we should expect 10-year yields to rise above 5% this quarter and keep pressure on equity markets.
We remain tactically bearish. The market cap weighted S&P 500 (SPX) looks relatively resilient when you compare it to the more cyclically-sensitive Russell 2000 (RTY). The RTY was one of the first major US indices to form a bearish distribution pattern back in late July and has already broken down. The equal-weight S&P 500 (SPW) looks very similar to the RTY with both indices threatening to make new YTD lows in the days ahead. The EuroStoxx 50 and Philadelphia Semiconductor Index are two other cyclically sensitive indices that have formed similar bearish distribution patterns. For the moment, both indices are holding above lows from last week. A break to new lows would likely correspond with the SPX testing the 4200 bullish inflection area from early June. With the SPX now in oversold territory, a break below 4200 depends on rising realized equity volatility. The CBOE Volatility Index (VIX) currently sits at 18 with levels north of 22 increasing the likelihood for the SPX to break below 4200. Ultimately, we expect the SPX will break below 4100 in Q4 as the index begins to price for a recession sometime in ’24.