Morning Notes — Watch Cyclical/Value Sectors

US economy: The increase in the June ISM non-manufacturing Index was the largest single-month gain in the index’s 23-year history. Of course, the decrease in April was the largest-ever decrease. Nonetheless, the June new orders component was notably strong, coming in at 61.6 vs 41.9 in May, and inventories, backlog and new export orders all pushed into expansion territory. In fact, all index components are now in expansion territory except one; employment at 43.1. And weaker labor markets tend to make recessions last longer than they should in the ‘normal’ negative feedback loop between weaker labor markets>weaker output>weaker corporate profits>weaker labor markets. Last Thursday’s stronger than expected June non-farm payrolls number of +4.8M vs consensus for +3.2M was impressive, but payrolls are still ~15M below February levels. The US economy is quickly recovering from the shortest recession on record, but we should still expect an incomplete recovery into next year to drive disinflationary trends and hold bond yields within ~25bps of current levels.

SPX: Last week, we saw defensive sectors and bond proxies outperform, while secular growth stocks also posted outsized gains. But for a sustainable rally in the S&P 500, we eventually need to see cyclical (Consumer Discretionary/Industrials) and value (Financials/Materials/Energy) sectors leading the market higher. We also continue to watch for relative strength in the S&P 500 Value Index (SVX), Russell 2000 Index (ETF symbol IWM) and cross market indicators like the Gold/Copper ratio (negative correlation). Almost all of the cyclical/value positions we follow are in short-term oversold territory and look like they want to press higher. Importantly, there have been two prior, short-term waves of cyclical/value outperformance since March that correspond with peaking US infection rates in first the Tri-State/Northeastern region and second in the Midwest/Mid-Atlantic region. If the infection curves from those two regions are applied to the recent surge in the South and West, we’d expect signs of a peak within ~2 weeks.