The Fed also made the decision to slow the pace of balance sheet runoff, a development that came sooner than some expected. While the Fed remains on hold from a rate cutting perspective, its willingness to accelerate the QT taper is a signal it is ready to act, if necessary, in our view. Looking ahead, investors are now very focused on the April 2nd reciprocal tariff deadline (see Tariffs: The Reciprocity Principle and The Tariff Playbook: Mitigation Strategies for more). While this catalyst could offer some incremental clarity on tariff rates and countries/products in scope, we think it's more a starting point for tariff negotiations as opposed to a clearing event. In short, a Fed put seems closer to being in the money than a Trump put though it probably would require material labor market weakness, a headwind for stocks initially.
So far, DOGE firings have had little impact on data like jobless claims or the overall unemployment rate. There may also be a lag between when employees are laid off and when these individuals show up as unemployed given the severance offered to most. The more important question for labor markets is whether the recent decline in the stock market, fall in confidence and rise in economic/trade uncertainty will lead to layoffs in the private economy? Our economists' base case assumes that these factors won't drive an unemployment cycle this year, but payrolls, claims, and the unemployment rate will be critical to monitor to inform that view going forward. In line with our long-standing view, equities have become less rate sensitive with the 10-year yield settling below 4.50% (i.e., lower yields have no longer benefitted stocks with the focus now on growth).
Exhibit 1 shows that the correlation between equity returns and bond yields has flipped decisively positive again, meaning that we're in a good is good/bad is bad backdrop from a growth data standpoint. Said differently, strong macro data including labor data is likely to be taken positively by equities especially given the recent concern around the impact of policy uncertainty on the path of economic growth. The flip side is that weaker macro data would be viewed negatively by equities.
As usual, looking at the S&P 500 alone does not fully describe the magnitude of the correction in equities. As we noted last week, equity markets got as oversold in this correction as they were toward the end of 2022 on a daily RSI basis. This begged the question, is this the bottom or the beginning of something more severe? In our experience, it’s rare for volatility to end when price momentum is at its lows.
However, you can get strong rallies from these conditions which is why we expected one to begin when the S&P 500 reached the bottom end of our 1H trading range (i.e., ~5500) on March 13th. From a trading perspective, the Morgan Stanley Market Sentiment Indicator ( Exhibit 2 ) may also provide a good guide. This indicator reached an extreme reading 2 weeks ago which was supportive of our tactical buy call at ~5500.
The bounce in this indicator has yet to reach a level we would consider neutral or overbought, which is another reason why we think equities can further rally in the short term. Notice how extreme the indicator got post the election, a level we do not think is achievable anytime soon given all of the uncertainties detailed in our recent research. Instead, we view the range observed in 2022 as a good barometer for how traders should think about sentiment both on the upside and the downside until further clarity is available. Bottom line, the combination of stronger seasonals ( Exhibit 3 ), a falling dollar/10-year yield, oversold sentiment/ positioning indicators and month/quarter end flows continue to make ~5500 support for a tradeable rally. As expected, lower quality, higher beta equities have led the bounce so far and that can continue in the near-term even though we are still advocating higher quality stocks in one's core portfolio for the intermediate term outlook.
While the S&P 500 has declined by just over 10% at its lowest, recent levels, many stocks are down more than 20% with a majority of stocks down more than 30% in some sectors, like Semiconductors and Consumer Durables & Apparel. For small cap stocks it’s been worse with the Russell 2000 index down almost 20% at its lowest levels with more than 50% of the stocks in the index down more than 30%.
