31.05.2023
Have we arrived yet?
The S&P500 has been climbing the wall of worry since the SVB collapse – it has shrugged off regional bank failures, commercial real estate worries, an inevitable recession that seemingly never comes, weak China data, the lack of market breadth and crowdedness in the same ideas and then risks around the debt ceiling.
However, with the S&P500 threatening to breach its trading range, we should note the following: the dollar has started to strengthen as the priced rate cuts are unwound, the curve has resumed its bear flattening from its already inverted state, long-end real yields have risen and rate vol has moved higher. Yet US equities led by the Nasdaq 100 have made further gains over May.
As a point of reference, the S&P500 earnings yield less 10yr bond yield gap currently stands at 1.8% - the lowest since summer 2007. The level of the equity risk premium does not seem to recognise any risks.
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Ordinarily, if the investor mindset shifts to “higher rates for longer”, it would put downward pressure on equity multiples, placing greater onus on earnings growth, making for a poor Sharpe backdrop. Yet the excitement on AI has so far masked this concern at the index level.
In markets, the phrase travel and arrive is used once the wall of the worry has been climbed and seemingly good news is already discounted. What does the machine suggest? The S&P500 is well explained on both Qi’s short term and long term models at 74% and 85%, respectively. The model value average on both models is ~4100 which put current spot on the rich side. However, what is particularly notable is that the S&P500 Qi model value has flat-lined and edged lower since the 3rd week of May.
Qi is clear on what equities need to see in the current regime to keep grinding higher: For the S&P 500 - lower rate vol, a weaker dollar, strong GDP growth, stronger metals, a steeper 5s30s curve and tighter credit spreads – Goldilocks? And so far in May we have seen weaker metals, higher rate vol, flatter 5s30s and a stronger dollar.
A similar pattern has emerged for the Nasdaq 100. Model value has been treading water and to move higher we need to see lower rate vol, a weaker dollar, higher GDP growth and metals – the same as for the S&P500. Several commentators have pointed out how resilient the NDX has been in the face of higher 10yr real yields. According to Qi, real yields are not currently a major driver of the index. Rather, lower rate vol and a weaker dollar are. And it is to these drivers where NDX looks over-extended of late. Now there are also concerns the need for the government to rebuild its TGA could drain Federal bank reserves. With the Nasdaq 100 now back to the 61.8% retracement of its 2021-22 sell-off, there is little room for error.
Have we arrived yet?
