There are times when the market’s desires and intentions are inscrutable. In other moments, the tape is pretty transparent in what it believes it wants — such as right now. The recent action suggests that stocks crave reassurance that the economy is steering clear of the ditch, Treasury yields will not nosedive further, the AI-investment theme still has runway and inflation is bee-lining toward 2% convincingly enough that a flexible Federal Reserve can be bold in easing policy before falling behind softening fundamentals. The market’s turn toward treating good economic news as positive for stocks is pictured here in a chart from Citi strategists, showing the three-month correlation between the S & P 500 and the Citi U.S. Economic Surprise index has turned sharply higher. This is how it goes when the threat is no longer bond yields running away to the upside and after the Fed has already said it’s in easing mode. Better-than-feared economic news and a hopeful spin on Fed intentions are roughly what the Street got last week, on the way to a 4% advance in the S & P 500 that took the index to within 1% of the July record highs, right at the upper edge of what now appears a two-month trading range. Back to the old highs It’s been a resilient showing after a rough first week of September, which for now is mapping pretty neatly onto the August pattern: A sharp drop to start the month, exacerbated by a worry-inducing monthly jobs report, followed by a brisk rebound backed by signs of consumer stamina, benign unemployment claims numbers, tame inflation and a supportive Fed message. The S & P 500’s low for the week was Wednesday morning, right at the 5400 level where it previously hit a low a week ago Friday after a tepid employment report. The flush came after a largely as-expected CPI report and in the wake of the presidential debate, which might have tightened the race. .SPX YTD mountain S & P 500, YTD Aside from bouncing off 5400, Treasury yields started to lift off 14-month lows – a likely “sell the news” response to CPI by bond traders who had been riding a furious rally in recent weeks. The Visa CFO at a conference had encouraging words about spending having picked up nicely, somewhat offsetting a troubling take on credit stress among lower-income borrowers by Ally Financial. That same morning, Evercore ISI economist Ed Hyman, the dean of Wall Street macro forecasters, flipped his call from an imminent recession to a soft landing , albeit characterizing the shift as a tough call given the mixed signals. The 5400 support level in the S & P 500 is noteworthy, too, for when it was first surmounted: June 12, the day of a softer-than-expected May CPI report, which first sent market pricing of a Fed rate cut by September 18 above 70%. This was a moment when soft-landing confidence got a jolt, which would peak a month later at all-time highs above 5660 on the S & P. Fed toss-up Of course, recovering back to the cusp of those old highs means rising to levels where the market has repeatedly failed to find aggressive buyers. And it would surely seem to invite the charge that investors are setting themselves up for disappointment after Wednesday’s Fed decision, which suddenly looks like a toss-up between a 25- and 50-basis-point rate cut. The case for a half-point reduction spread fast late in the week, with former Fed officials Loretta Mester and William Dudley saying they would, or could be persuaded to, go along with such a move. Articles from Fed-watcher reporters at the Wall Street Journal and Financial Times hit in tandem on Thursday to suggest 50 basis points would not be incompatible with a still-healthy economy given how far the Federal funds rate (5.25-5.5%) is from inflation (around 2.5%). History says that slower, more deliberate Fed easing cycles are typically better for stocks than faster, urgent ones, strictly because the latter type is almost exclusively associated with recessions. But a half-point start doesn’t, in itself, mean a headlong pace of easing. Or at least that’s the story last week’s equity buyers are going with. A reminder that stocks’ experience after an initial rate cut in a cycle is overwhelmingly dictated by whether the economy continues to grow before and after it, as this Deutsche Bank snapshot makes clear. Whatever the Fed does and says next week, it’s tough to envision the market fully outrunning the late-cycle ghosts and the shadow of a potential policy mistake. John Kolovos, chief technical market strategist at Macro Risk Advisors, says, “The two-year [Treasury] yield’s response to the cutting cycle will guide us.” This yield is down a full percentage point in the past month to 3.58%. “So long as yields don’t get much lower than 3.25% support and start to build a floor, this cycle will end up being slow and risk-friendly,” Kolovos adds. Don’t fight the Fed? Credit markets remain firm. Forward 12-month S & P 500 earnings forecasts continue to rise smartly, now approaching $270. For sure, the market trades at 20.9-times that level, according to FactSet, no one’s definition of a bargain. But, thanks to the past two months of sideways churn, that’s down from 21.7 when the S & P first hit its current level in July. While the flagging leadership of mega-cap tech has caused plenty of bumps, the broader list of stocks have held in there, more than 60% of tickers in a long-term uptrend. Also since the mid-July peak, sentiment has cooled from pretty toasty readings. The National Association of Active Investment Managers equity exposure in mid-July was 94%, and is now 82%. At the peak, the American Association of Individual Investors survey had bulls outnumbering bears by 27 percentage points; the spread is now 10. This setup doesn’t amount to a plush cushion underneath the market, necessarily. And the rally last week could well have front-run any potential positive inference from the Fed’s move next week. And, as is constantly mentioned, the second half of September is historically more hazardous than the first. So it makes sense to be prepared for more sudden macro mood shifts, as always, while recognizing that the “Don’t fight the Fed or the tape” rule is a rallying cry of the bulls, for now.
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