Grinding up, grinding still

S&P 500 proved key point of yesterday‘s extensive analysis – the buyers still have higher to go but the key resistance is approaching. After quite a couple of days, tech stocks took a breather as rotation into value led by oil stocks, materials and industrials (so as to confirm decent market breadth) took the spotlight. Financials continued doing relatively well – while XLF is moving up, KRE keeps lagging, which only reflects the precarious position of smaller banks, and concentration within the sector that I told you about in mid Mar already.

No matter how poor ISM manufacturing PMI came (46.3), it‘ll take some time still for the Fed to relent from tightening, or alternatively for the bond market to get convinced that the Fed would still do one more 25bp hike, and then keep rates there (probably only until a truly catastrophic event strikes, but I‘m not looking for one to hit us really soon, no.

Don‘t forget the big picture:

(…) The rally is of course heavily dependent on the sectors I talked often recently – tech, semiconductors and communications. The dependance on heavyweights is all too palpable, and the flagging broader participation would come to bite, but not yet. Let NVDA, META, AMD and TSLA do the job for now. They are the generals that would be left standing while the troops at a future point refuse to participate in the upswing (not immediately on the horizon).

At the same time, financials continue limping as deposits are still leaving the banking system. Given the state of the long end of the curve and unyielding Fed attitude towards tightening, that‘s a watchout for the days ahead. Merely a watchout, because the relief that no other bank is in immediate trouble (hitting headlines), can and is winning the day.

The greatest conflict though persists - in bonds forcing the Fed to pivot, and Fed refusing to indicate so. Consider that 100bp rate cuts in 2023 are already priced in, but the Fed keeps ruling them out. Justifiably so I say – it can continue keeping rates restrictive (letting disinflation continue as best as it can) while providing liquidity through the back door so as to prop up the banking system that suffers through having taken the only route left in the quest for returns in the low rates era, which is going out on the long end (and is predictably hit when the Fed has no other choice but to keep raising thanks to inflation).

The Fed monetary policy uncertainty thus created in the markets, is obvious – the Fed has to shield the banking system from rate raising (keeping rates restrictive) consequences. At the same time, the central bank has to keep a close eye on corporate credit markets so that these don‘t seize the way they did in Dec 2018 – and fresh debt issuance and rollover ever since SVB went under, are not at all encouraging. Note that 25% of investment grade corporate debt has to be rolled over this year, and the activity review of junk corporate bonds and leveraged loan markets (private equity) doesn‘t look more optimistic.

There you go with one explanation of why financials are lagging this badly. The retreat in inflation continues, but expect goods inflation to kick in, and not only because of the rising oil prices, while services inflation would remain quite stubborn. Earnings recession is to be getting more often mentioned in the weeks ahead, while the continued Fed restrictive stance keeps carrying the risk of something new breaking somewhere else. I‘m not vocally calling for a credit event, but for a sufficiently bearish catalyst slash risk in the nearest say 2 months before either the Fed starts doing market‘s bidding, or the other way round.

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Let‘s move right into the charts.

S&P 500 and Nasdaq outlook

Even 4,115 is too far for today (let alone 4,078, and 4,039 won‘t come this week either) As said yesterday, the short-term outlook remains undeniably bullish, but it‘ll be of backing a filling first as the rally is short-term quite overstretched.

Credit markets

Bonds are taking a breather, and unless they start really weakening, I wouldn‘t be reading too much into their today‘s (upcoming) performance.