Morning Notes — S&P 500 Outlook

The S&P 500 outlook is in focus as the index has gained over 4% to start the year and is now trading above its 50, 100 and 200-day moving averages. YTD gains have been fueled by short-covering with baskets of high short interest stocks rallying more than 15%. Detractors cite a similar dynamic during bear market rallies from last June and October, but lasting cyclical bull markets also start with increased short covering. The index broke near-term downside momentum when it closed above 3925, but we expect strong technical resistance in the 4100-4200 range will hold for now. An eventual break above that range should be preceded by an end to the 5/10-year yield curve inversion.  While the 5/10 yield curve inversion has narrowed from -26bp in mid-October to just -8bp today, two more Fed rate hikes in the months ahead could temporarily interrupt the process. A resumed flattening in the belly of the curve would discourage the Fed pivot long enough for a successful retest of last year’s low near 3550. Two more Fed rate hikes without a coincident widening of the 5/10 curve inversion could take the SPX through 4200 with downbeat sentiment and light positioning dynamics leading to accelerated upside. The near-term bearish scenario includes a resumption in Energy price inflation likely due to increased demand out of China. A long-term bearish scenario likely requires core inflation ex-shelter and services inflation to remain at current levels or move higher based on ongoing tightness in labor markets.