Morning Notes — SPX Outlook

We discuss SPX outlook as equities rebound following improved UK sentiment. The driver is Chancellor Hunt’s plans to reverse the bulk of Truss’s tax cuts and scale back her large energy subsidies. It’s a step in the right direction but won’t fill the fiscal gap or undo market damage caused by policy accommodation during a time of elevated inflation. Reports suggest Tory MPs are still pushing to remove Truss as PM, possibly within days.

Equities also react favorably to late Friday comments from the Fed’s Bullard who advocated in favor of getting to the Funds Rate ceiling faster, but not increasing the ceiling height. The ceiling he’s referring to would be the ~4.6% rate (upper bound would be 4.75%) implied by the last dot plot vs. bond markets pricing ~4.95. He added the Fed should shift to data dependency once it reaches the ceiling. With the upper bound now 3.25%, Bullard’s preference of getting there sooner would start with a 75bp hike in November, possibly followed by a 75bp hike in December.

SPX: The S&P 500 (SPX) is presently testing near-term technical resistance at ~3690. Near-term pain trade dynamics favor increased upside momentum as most view the rally in the context of a 2-day bear market spike. SPX closing levels north of ~3690 will likely lead to increased upside momentum with another small hurdle at ~3745. The first major area of technical resistance sits between 3900-4000, which we expect to cap the rally if terminal Fed expectations remain elevated above ~4.80. The sharp upside reversal today reflects deep oversold conditions as terminal rate expectations are only down ~2bp to 4.94%. Terminal rate expectations drifting toward ~4.50% would likely take the SPX to the 4100-4200 range in Q4. Terminal rate expectations that approach ~4.50% likely requires some deceleration in wages (11/4 Jobs Report) or realized inflation (11/10 CPI). In the meantime, any rally above 3690 would need to draw its fundamental fuel from better than expected Q3 earnings and/or lower US dollar. Contrarian indicators remain highly supportive with extreme bearish sentiment and light equity positioning. Hedge Fund short selling is as crowded as it was prior to the June rally and retail investor equity positioning is now below June levels.  Downside support remains in the low-3500s with the next big support zone at ~3350 and those support levels will likely be challenged if terminal rate expectations move above 5%.

Next: There are 9 scheduled Fed speeches this week with likely implications for terminal rate expectations.  This is also the first full week of earnings with a focus on Financials, Consumers and Health Care. Financials have reacted well to early large cap bank earnings and the reaction to earnings from these other sectors will likely set the tone for CQ3 earnings season.

CPI: Shelter prices showed a robust increase of +0.7% MoM in September’s +0.4% MoM headline increase in CPI. However, higher frequency data shows rent and housing prices moderating since May.  The lag in CPI shelter prices looks as long as 8-10 months, which implies a rolling over of this component might have to wait until Q1’23.