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The S&P 500 (SPX) jumped early last week as rates fell and the dollar weakened. However, after the arrival of economic data throughout the week that supported higher levels of accommodative monetary policy, the bearish market rally is likely to be short, allowing the S&P 500 to continue its August pullback. And will come back to 4,100. in the next few months.
The rally from mid-March to mid-July may have been one of the most incredible bullish traps since the 43% Nasdaq 100 surge in the summer of 2000. The trap, inspired by a fictional narrative of melting inflation, allows the Fed to cut rates and ease monetary policy as the US economy heads into recession. While there may be some early signs that the economy may be starting to soften, it is still very strong and resilient and the Fed is a long way from changing its expected restrictive monetary policy path.
trading view
rates
Once again, the stock market thinks bad news is good news as traders can’t help but think the Fed will come to the stock market’s rescue at the first sign of slowing growth. The “bad news” began on August 23, following weak preliminary PMI data points across Europe and the US, which drove nominal rates down sharply.
Then, last week, weak job openings data (JOLTS) and a weaker-than-expected ADP jobs report sent rates down again, despite a massive revision for July. But on Thursday, a lower-than-expected core PCE data point and hotter PCE core services ex-housing data helped rates stabilize and then move higher on Friday after a stronger-than-expected non-farm payrolls number and a warmer-than-expected helped in ISM Manufacturing Report.
Bloomberg
If one searches hard enough, evidence of some economic softening can be found. However, the data remains strong and suggests the market may continue its past trend of raising rates higher behind the yield curve and piling back into the dollar. After all, economic models such as Atlanta Fed GDPNow and Bloomberg Nowcast suggest there is hardly any change in the real GDP estimate for the third quarter after the data onslaught.
Bloomberg
This suggests that the 10-year and 30-year rates remain higher and will likely move back to the upper end of the ranges set before August 23 and move down and potentially higher.
Bloomberg
dollar effect
Additionally, better economic data out of fear will continue to support the dollar. The dollar index recovered all its losses after the weaker-than-expected JOLTS data and returned to its highest level since September 1. From a technical point of view, the dollar index could rise to around 106 in the near term and eventually sustain. Until about 111. I discussed this in a recent TV interview on Fox Business Channel’s Making Money with Charles Payne.
trading view
Many investors fail to understand how important the dollar is to the stock market and the impact a stronger dollar has on stock prices. This makes US exports less competitive abroad, undermining revenue and income growth. Additionally, it will strengthen financial conditions, removing leverage from the system. With the addition of China, the sum of the G5 central banks’ balance sheets in dollar terms is shrinking. One reason for this move is the strengthening of the dollar. This liquidity is highly correlated with the S&P 500 over time, making it extremely important, and the recent divergence is shocking.
Bloomberg
This creates a problem for equity investors because big moves like August 29 give the impression that all is clear, and that the worst of August’s decline is behind them. But in reality, the rise in the S&P 500 on Tuesday was due to a negative gamma arrangement in the equity market due to a weak dollar and falling rates, as well as options market conditions. The momentum created a huge rally as dealer inflows led to buying as the index moved up, and this rally is likely to taper off in the coming days.
Gamma Labs
Complicating what could be a significant factor is the recent jump in oil prices, which have risen to $86 a barrel, and mean CPI swaps raise the inflation outlook for the next few months as gasoline prices rise. Used to be.
CPI expectations have risen to 3.6% in August, to 3.4% in September and to 3% in October. These don’t seem like meaningful moves considering where the inflation rate was at this time last year. However, these CPI expectations can only increase if oil prices continue to climb. The longer the headline remains above the Fed’s 2% target, the longer the Fed will have to keep rates high, increasing the risk the Fed will need to do more.
Bloomberg
yes, basics matter
This will complicate things because almost the entire rally in the stock market has been due to multiple expansions, not improvements in fundamentals, as the S&P 500’s PE ratio increased from about 18.1 on March 24 to about 20.8 on September 1. If the index’s multiple were to shrink back to 18.1 times its 2023 earnings estimate of $217.26, the index would return to trading at 3,930.
This brings us back to the dollar as the higher change in PE is primarily due to easing financial conditions, which is directly linked to the weaker dollar value. So, should the dollar continue to strengthen, this will lead to further contraction. S&P 500 earnings overall could also decline due to FX headwinds due to the stronger dollar.
The combination of higher rates and a stronger dollar, combined with rising oil prices, could make things difficult for the stock market for the remainder of the year, as prices slide back to lower levels, and financial conditions tighten. Which could potentially lead to a decline. A revisit to 4,100 in the next few months, possibly even higher depending on the situation thereafter, will shock the bulls into realizing that fundamentals and macro trends are what really matter.
Source: seekingalpha.com
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