November 22, 2022
The mid-October conditions that had us looking for a Q4 rally included technical signals (deep oversold conditions with momentum divergences) that were apparent in all major market inflations over the last 13 years. Over that period, there were four major inflections and five bullish signals – so it’s not perfect. The S&P 500 (SPX) is up 11% since mid-October and showing signs of a developing base pattern, but the fate of this particular bullish signal will depend on near-term realized inflation data.
Next: There’s no consensus expectation yet on November CPI (due 12/13), but details from the October CPI report give us confidence we’ve moved past peak inflation. We expect November headline CPI will come in up +7.2% YoY, down from +7.7% in October and core CPI to come in at +6%, down from +6.3%. And this should be enough to keep the SPX from retesting the lows in the ~3500 handles.
Next year: October core CPI excluding shelter was actually negative, but sequential core disinflation might be slow to materialize as shelter prices work on a 9-12 month lag. We see core CPI decelerating into the 3-3.3% range by Q4’23, which likely takes 10-year yields down to ~3.4% by YE’23 vs. ~3.8% today. If realized, that 10-year yield forecast will have positive implications for broad equity markets with a continued bias in favor of value sectors. Growth sector outperformance will likely require disinflation and Fed rate cuts rather than a pause. And Tech (software in particular) multiple expansion likely requires 10-year real yields to fall below +65bp from +150bp today. Ten-year inflation breakeven yields are currently sitting at 230bp. A 3.4% nominal 10-year yields and assumed breakeven yield of ~240bp would keep real yields around +100bp.