S&P 500: The Momentum And Fundamentals Point To The Downturn - I'm Going Short

seekingalpha04-13

The March CPI inflation data does not support the Fed's "inflation bump" thesis, and the Fed will be forced to make a hawkish turn.Thus, in my opinion, the Fed is not going to be able to prevent the ...

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John M Lund Photography Inc The initial bullish thesis My outlook for S&P 500 (SPY) published on December 20th was titled \"Pump and Dump\", and my target for the S&P 500 index (SP500) was 5300, which was one of the most bullish outlooks on Wall Street and Seeking Alpha, at the time. Specifically, I predicted that the S&P 500 would rise to 5300 by June, and then sharply correct in the second half of the year. The bullish thesis for the first half of 2024 was based on the expectations that the Fed would start cutting interest rates, possibly in May, as the disinflationary process progressed. The bearish thesis for second half of 2024 The bearish thesis for the second half of the year was based on the prediction that inflation would start rising as the base effects expire in June, at which point the Fed would be forced to make a hawkish turn - this means the interest rates would start rising again. The S&P 500 came close to my 5300 targets in April, so the bullish phase seems to be complete. The recent \"hot\" inflation data for January/February/March, all coming at 0.4% MoM not only delayed the expected cut in May or June, but possibly reinstated the \"higher-for-longer\" policy, meaning no cuts in 2024 (until a recession). The point is, the main trigger behind the bullish thesis is now expired, and, thus, it's time to Sell. In fact, interest rates have been rising since January, but it seems like the threshold at which they start affecting the stock market has been reached (possibly 4.35% yield on 10Y Treasury). The main trigger for the bearish thesis is the March CPI report, which came at 0.4% MoM above expectations of 0.3% MoM, and it's the third consecutive month with a 0.4% MoM rise. Here is the chart for core CPI inflation MoM. The Fed's view that the \"hot\" January and February inflation data was a \"bump\" was disproved by the March inflation data. Nothing in the macro picture or the data points to a lower reading for April. Trading Economics Macro context The macro context of the current theme is simple:  1) the yield curve has been inverted for the record time, and thus, it will eventually produce a recession as the long and variable lags of monetary policy tightening hit the economy, 2) the maturity wall of refinancing is also facing higher interest rates, which points to higher defaults and a credit event (despite the recent rush to refinance at lower rates, as reported by Bloomberg), 3) the Fed is unable to lower interest rates to avoid the recession and the credit event due to higher inflation.  Thus, over the near term, the stock market is likely to react negatively to the repricing of the expected Fed cuts to zero. However, over the intermediate term, the stock market is facing a recessionary bear market with the credit event (maturity wall reference). This is going to be the time when the Fed cuts. So, the Fed could still cut in 2024, but that's going to be in response to the recession - and not normalization as currently expected. Thus, the S&P 500 is facing a prolonged downturn. I could not point to the level at which the S&P 500 could bottom, it will depend on the macro situation at the time. But the market usually bottoms out as the recession reaches the worst point - the second derivative rally. Big tech earnings The second trigger behind the bullish phase was the GenAI theme and the corresponding earnings results from the mega-cap tech stocks for the Q4 2023. In fact, the broad stock market tried to sell off after each \"hot\" inflation reading in February and March, but the earnings results from companies such as Meta (META) and Nvidia (NVDA) kept the uptrend momentum intact. The bullish phase was entirely based on the PE multiple expansion for S&P 500, which suggests that the market was building very high expectations about future growth. Thus, most of that growth is actually priced in. The bubbles burst when the growth expectations disappoint. Thus, the Q1 2024 earnings season will be important. Given the expectations that tech companies front-loaded AI-based spending in 2023 due to the fears of being left behind, it is very likely that some of these mega-cap tech firms will disappoint with earnings or guidance, for example Nvidia. But more importantly, on the macro level, the earnings expectations for 2024 and 2025 don't consider the possibility of a recession. Given the previous discussion in the macro context section, the recession is very likely, either towards the end of 2024 or beginning of 2025. Thus, the mega-cap tech earnings expectations will have to be significantly downgraded. Given the heavily concentrated market and the outsized influence of big tech, the broad market could fall sharply. The momentum All this discussion about macro factors like inflation, the Fed, and earnings could be very interesting, and yet, most of the market participants are glued to the chart. These are the trend-followers and momentum traders. They buy simply when the price is rising, and sell when the price is falling. Thus, obviously, the bearish phase has to be verified with the chart. The current SPY chart shows that the momentum is changing. First, it seems like the 20dma is decisively broken. This was the key support level of the bullish phase uptrend. Currently, the price is testing the lower-low level, which when broken will push the price to 50dma. Technically, the key support will be the 100dma at 488. The point is that the SPY price is starting to confirm the loss of momentum and a possible trend change, which is consistent with the deteriorating fundamentals. Barchart The implications I actually downgraded SPY on February 9th from a Buy to a Hold, as the Fed cut expectations were getting reduced. In mid-January, the market expected 6-7 Fed cuts in 2024, and obviously in that situation the default position was to be Long - that was the bullish phase. But the Fed also stated at the January meeting that \"it is not going to be appropriate to cut interest rates until...\", which signaled the return of the \"higher-for-longer\" in my book, and the market started to reduce the number of expected cuts as well. I wrote at the time:  The only thing that's working right now for the broader stock market is the GenAI theme, and that can continue, so I am not recommending a Sell yet. I am downgrading SPY from Buy to Hold. What does this mean? It means I would not chase this rally with new money, I would not be buying at this point. This does not mean SPY is a Sell, at least not yet. Personally, I am reducing the SPY Long position towards the Neutral level and look to either: 1) Buy the possible deep correction; or 2) look for the opportunity to Short if the rally continues.  Given the recent developments, as outlined in this article, I am downgrading SPY to a Sell - and going short. Note on the SPY sector leadership The S&P 500 rally YTD actually broadened to cyclicals such as Energy (XLE), Financials (XLF) and Industrials (XLI). The economy accelerated in 2024, and ISM manufacturing is now over 50. Well, that's the problem. The Fed prematurely eased the financial conditions, and now inflation is accelerating as well. Thus, the Fed will be forced to delay the cuts - until the recession. That's bearish. SelectSectorSPDR The risk to the short thesis Obviously, the main risk to the short thesis is the momentum. The uptrend in S&P 500 is weakening, but the sentiment is still positive, and the uptrend could continue due to the sentiment alone, particularly in the mega-cap stocks, and especially if the earnings don't disappoint. Thus, the short position has to be managed accordingly.  With respect to fundamentals, we have to wait until the end of the month for the PCE inflation data to confirm the CPI inflation data, and then wait for the April CPI report to confirm the hot March CPI inflation data. In the meantime, the price of oil is the key real-time indicator of inflationary pressures. So, a sudden fall in the price of oil (USO), with a weakening US Dollar (UUP) could signal renewed disinflationary pressures, which could benefit stocks over the near term.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":1,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2427037756"}