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19.12.2022
Between a rock and a hard place?
Qi model confidence in the S&P 500 continues to fall. Peaking in early October at 84% and trending lower since to 63% currently. Under the hood, this is likely a reflection of the shift in major drivers of the index.

Over this period, we have highlighted that this year’s strong negative relationship between bond yields and equities has shown signs of coming off its extremes. This is clear in the chart below showing that the negative sensitivity between real yields and the S&P 500 is becoming a less significant driver.
Ak1
The challenge to come back into a strong macro regime has not been aided by last week’s hawkish central bank meetings – which has served to keep policy uncertainty high into 2023. This uncertainty will be reflected best in the sensitivity to corporate credit spreads, which remain a major driver of the index.

The prior observation that bad economic news is good news for the equities, allowing the Fed to take their foot off the financial conditions pedal, is shifting. Policy error fears are being reflected more in a greater focus on economic growth.

Qi’s sensitivity to economic growth and metals has been trending higher. If the central banks insist financial conditions need to remain tight, hard landing fears increase.
Ak2
This leaves risky assets between a rock and a hard place given the resolve of both the Fed and ECB last week – weaker economic data raises the spectre of recession; stronger data raises the spectre of rates remaining higher for longer.

This likely keeps equities in a fat and flat range with bounces being sold into until the regime becomes clearer.

Qi shows stocks relative to bonds moved into undervalued territory over December – but this again a reflection of the changing dynamic and not a signal.

The relative undervaluation is precisely because bond yields and stocks have seen a more positive relationship over the last month – yields down and stocks down.

If growth fears move to the fore, the risk remains that model value remains under pressure.
Ak3
The majority of GICS level 1 sectors saw spot prices move below Qi model prices by the end of last week. However, model values are showing waning momentum.

We warned on Energy trading rich in an insight note in late November – it has been the weakest sector over the last month. Energy now stands at -0.8 sigma to model value.

However, again we are wary of reading into this too much when it is the most sensitive sector to inflation expectations, alongside high sensitivity to EM FX / China re-opening.
Ak4
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