May 1, 2023
The S&P 500 is extending to the upper end of its technical resistance range below 4200. A sustained break above ~4200 seems unlikely given bearish momentum divergence seen on Thursday 4/20 and Friday 4/21. Narrow leadership and weak market breadth also make us skeptical of a potential upside breakout. This is a defensive signal usually seen at the end of a maturing cycle.
The most recent bullish development has been the improvement in Q1 earnings metrics. At the end of last week, the blended YoY EPS growth rate was ~0% vs. -6.7% expected at the beginning of earnings season. Zero earnings growth isn’t a strong argument for higher levels, but it probably removes or defers the most bearish scenario. Other bullish talking points include the potential for a near-term Fed pause and the reopening of the corporate buyback window. A Fed pause will be good for equity markets but valuations remain challenging at ~18x forward SPX estimates. To us, higher levels require a full cyclical recovery driven by monetary accommodation and expanding money supply. The most recent data shows money supply contracting at a YoY rate of -4%. A Fed pause with ongoing QT also keeps the yield curve inverted, which keeps pressure on banks and other business that use a form of the carry trade. The debt ceiling stalemate has been cited as a near-term overhang for the economy but spending cuts out of Washington would help ease inflationary pressures and move us closer to a period of policy accommodation.
The actual ex-date for the debt ceiling still looks like early-August. The market-based implied probability of default over the next year has increased to 3.9%, but remains below the 7% peak level observed in 2011. Nominal US sovereign CDS spreads are currently wider than they were in 2011, but it’s important to remember that rates were at the zero lower bound in 2011. We expect T-Bills maturing in July and August will begin to trade cheap as the ex-date gets closer. We also expect a flight to quality move in the belly of the curve to drive 10-year yields lower by ~30bp. This would take 10-year Treasuries to 3.25%, which would come close to levels confirming a March peak in nominal yields.