June 8, 2020
SPX: Cyclical sector leadership is important for the sustainability of broad market gains. The early outperformance of cyclical sectors in late March gave us extra confidence in the sustainability of the rally off the 3/23 low. It also kept our minds open to the possibility the SPX could break through technical resistance at ~2950. Cross market indicators like the performance of Copper relative to Gold gave us more confirmation and still sending a powerful signal.
Dispersion: Over the past ~3 weeks, we may have lazily used the term ‘rotation’ to describe the recent outperformance in cyclical/value sectors. But rotation implies that investors are rotating out of other sectors as a source of funds and that’s not really occurring at the moment. The recent outperformance of value over growth, cyclical over defensive and small cap vs large cap is something that always happens at a turning point in the business cycle. Activity data has clearly inflected higher over the past three weeks and coming ahead of expectations. The direction and timing meets our forecast, but the magnitude of the beat has been larger. But for this ‘preference’ to turn into ‘rotation’, you probably need to see a sustained move higher in bond yields, which ultimately reflect market expectations of future inflation. Btw, in addition to the Fed meeting, this Wednesday also brings May CPI with expectations for 0% month-over-month rates for the headline and core rate. The April report showed that core CPI on a year-over-year basis had already stepped down a full 100 basis since February to 1.3%.
More: In total, we expect this current period of cyclical sector outperformance will last ~2 months, which means it has a few more weeks to go. A reversion back to large cap secular growth leadership doesn’t mean the SPX is heading back to mid-March lows, but should start a small period of normal consolidation into prior resistance around 3000.