Markets stall as investors are reminded about the continued headwinds

Thoughts

• The momentum of the strong market recovery is showing signs of stalling, with last week breaking a four-week winning streak for the S&P 500® Index, reminding investors of the headwinds that remain. The Index approached the technically important 200-day moving average and could not breach it. While the 15% bounce since mid-June has been impressive, there is concern that it was led by a group of high beta, low quality, highly shorted stocks that has hints of the “meme stock” mania of last year.
• A divergence continues to exist between the allocation to equities by retail and institutional investors. A Bank of America survey shows that private clients have an allocation to equities of 64%, down slightly from the 66% earlier in the year, but well above the 56% average since 2005. A similar survey of fund managers shows cash levels are still well above average, and near the highest level since the technology bubble. There is near record pessimism about the global economy and corporate profits. A net 58% expect a recession over the next 12 months, just below the levels in the financial crisis and the pandemic. Hedge fund managers are also quite pessimistic, with net futures positions for the S&P 500 near the lowest level since June 2020.
• The equity market this year has been a series of runs based on shifting sentiment. The market priced in a lot of bad news in June but following an impressive rally over the past two months, there are signs of exhaustion that could lead us into negative territory. Still, the likelihood is high that 12 months from now, investors who buy today will be happy with their decision, even though they’ll experience choppiness along the way.

News

• The next likely catalyst for markets could be Friday’s speech by Fed Chair Powell at the annual Jackson Hole event. Press reports note a likely hawkish tone, as there is some discomfort among Fed officials around the perceived stall in policy. This speech may not determine whether September’s rate hike will be 0.50% or 0.75% (odds are currently about 50/50) but will likely be a reminder of the challenge of getting inflation under control. The Fed Futures curve embeds between five and six 0.25% hikes between now and March, with cuts having begun in May.
• Last week provided our latest view into the state of the consumer, with earnings reports from Walmart, Target, Home Depot, and Lowe’s. The report on retail sales showed consumers are still spending, but at a slower pace, and are shifting their budget to necessities versus discretionary purchases, reinforcing the tone from retail executives. Back-to-work oriented spending, such as transportation, food, and childcare are also surging, further challenging consumer budgets. Real wages have been negative for 16 straight months, forcing an increasing number of families to rely on credit cards for everyday spending.
• Economic data continue to provide a mixed picture on the Fed’s attempted “soft landing.” The index of leading indicators has a strong track record in predicting recessions when turning negative is currently flat from a year ago. This is reinforced by the yield curve (measured by the spread between the 10-year and 2-year yields) continues to be negative at levels not seen since the technology bubble. Alternatively, the Citigroup Economic Surprise Index has rebounded to near neutral, reflecting more conservative economist expectations. Bulls continue to point to the healthy job market, which is historically inconsistent with a recession.

What to Watch

• The Fed’s Jackson Hole event will be the primary focus of investors given the market fixation on Fed policy. Economic data include PMI data and new home sales Tuesday, durable goods and pending home sales Wednesday, revised second-quarter GDP on Thursday, and the PCE deflator, personal income and spending, and consumer sentiment on Friday.