Sentiment shift leads to market weakness

Thoughts

• Equity markets are looking to avoid their first three-week losing streak in a year, as the tone of trading has turned notably risk-off. The S&P 500® Index has declined in eight of the past 10 sessions and has brought the Index below the 50-day moving average for just the second time this year. Despite the weakness, the S&P 500 begins the week just 2.3% below the record high and has returned 19% for the year. Weakness in equities has not yet driven a flight to quality in the bond market, as the 10-year Treasury yield remains above 1.30%. Credit spreads remain tight despite record corporate and high-yield issuance.
• The headwinds facing the market remain unchanged, but the buy-the-dip approach by investors that drove 54 record closes for the S&P 500 has faded. This is echoed by a decidedly bearish shift from Wall Street strategists, including Bank of America, Morgan Stanley and Citi. Investor sentiment and behavior have again diverged, with the AAII sentiment survey showing the largest weekly decline in bulls in over two years, with the largest inflow into equity funds ($51 billion) in six months. Similarly, the Bank of America Global Fund Manager Survey showed a dramatic drop in expectations for global growth to the lowest level since April 2020, with the outlook for earnings growth at its weakest since May 2020. Despite the negative outlook, half are net overweight equities.
• The trend of news flow has not changed, but reactions by investors have become notably more bearish, likely leading to a period of volatility.

News

• As the targeted deadlines for the $3.5 trillion domestic spending and $1.0 trillion infrastructure deals approach, the sides remain far apart. Progressive and moderate Democrats are split on the size and scope of the reconciliation bill, with senior leaders seeking to scale back the size of the package. Swing voters Senators Manchin and Sinema are unwilling to support the $3.5 trillion package, while progressives vow to block the infrastructure bill if the reconciliation bill fails. While the fiscal spending packages continue to attract the most headlines, the looming debt ceiling debate is a greater source of concerns, as there is currently no clear path towards agreement. Treasury Secretary Yellen warned that failure to raise the debt ceiling soon would likely precipitate a historic financial crisis.
• Asian markets remain weak, driven by developments in China. Property developer Evergrande has $300 billion in debt (largest publicly traded development company in the world) and faces the prospect of missing interest payments this week. Equity prices for the company have dropped 80% this year and trading on bonds have been halted. Chinese officials continue their regulatory crackdown, most recently with developers in Hong Kong. Observers worry about a contagion beyond the borders of China, along with further regulatory actions by the Chinese government.
• Domestic data steadied a bit ahead of this week’s FOMC meeting, with CPI, retail sales, and consumer sentiment easing some inflation and growth fears. High-frequency data, however, continue to reflect slowing activity, with time outside the home now 6.8% below pre-pandemic levels, versus -3.6% in early July. The sluggish high-frequency data in the U.S. is beginning to be reflected in management commentary. Several early cycle companies in food & beverage, building products, industrial equipment, and housing have pointed to headwinds from supply chain shortages, labor difficulties, and input cost pressures. Earnings estimate revisions have leveled off for 2022, with an increase of just 1% in the past six weeks.

What to Watch

• The Fed returns to the stage this week with an FOMC meeting Wednesday that may provide clues on the timing of the taper. Economic data are dominated by housing, including housing starts on Tuesday, existing home sales on Wednesday, Markit PMI and leading indicators on Thursday, and new home sales on Friday.