Raindrops on Rallies and Wobbly Conviction

Since the S&P’s most recent low on June 16, the market has made an attempt at a rally. Despite being up about 4% in two weeks, the tape was still muddied with down days and some investors remain unconvinced of durable upside.

As much as I’d like to believe in the start of something positive, market positioning still decidedly reflects risk-off sentiment and, when considering whether we’re out of the woods, some of the classic signals continue to flash “not yet.” Since markets tend to lead macro indicators, we have to pay attention to what they’re telling us.

There are complicated ways to look at risk appetite, and there are simpler ways. I’m choosing to keep it simple this week because this data is quite clear. Looking at the comparison between Consumer Discretionary and Consumer Staples sectors can be a solid indicator of not only how consumer sentiment is trending, but also how investors are feeling about the prospect of consumer spending — turns out, still pretty weary.

Along with the clear outperformance of Staples, is the clear outperformance of Utilities and Health Care — two classically defensive sectors. Additionally, a couple industry groups we can look to for signals of risk appetite and durable goods spending are semiconductors and autos, respectively. Both have taken it on the chin in Q2, with semis down sharply over the last month.

Survey says: don’t believe the rallies yet.

How Do You Solve a Problem Like the Yield Spread

Aside from the equity market, the bond market continues to send similar signals that shan’t be ignored. The 2s/10s yield spread can’t seem to widen, and consequently, can’t seem to stop inverting.

One could make the argument that the rise in the 10-year yield is an indication of less fear, since long-term yields tend to fall when investors are worried. But the fact that the 2-year yield remains so elevated, due to inflation and fear of Fed hikes, creates more of a headache for investors. While neither of the two inversions so far have been deep or long-lasting, repeated dips below zero and a spread of less than 10 basis points for the last three weeks isn’t a sign of exuberance.

The Hills are Alive With the Fear of Recession

We’re not done with this bear market yet, in my opinion, and the market signals currently agree. The hard truth is that we may not be done with it even if we find out we were in a recession in Q2. There hasn’t been enough damage done to inflation yet, and the Fed has shown no intentions of slowing its roll. The bigger question that is now emerging is whether we run the risk of a double-dip recession; with the first one being a “technical,” but not painful, recession and the second being of the more classic recession variety — one that resets inflation.

Although the market will start to turn around before the economy does, I don’t expect a lasting reprieve from the current tone until later in summer or early fall.

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