The S&P 500 was trading in the 3900 region just before the November 2nd FOMC meeting. At the post-meeting press conference, Fed Chairman, Jerome Powell, put a hawkish spin on the Fed’s written statement and caused the S&P 500 to fall to the low 3700s by the following day. It closed that week at 3777. 

Yet, at the time, despite Powell’s hawkish rhetoric, a multitude of signs pointed to higher equity prices in the ensuing weeks:

• Inflation looked set to roll over (it did, at least for the most recent CPI report).

• Politicians were putting pressure on the Fed (prior to the looming election) to slow or stop its rate hikes.

• The U.S. was pushing Ukraine to be open to negotiations with Russia.

• Gold was trading as though real rates would start to decline (they did).

• Speculators in the dollar (who tend to be directionally correct) had been heavily short the dollar since mid-October.

• A trader placed a large bet that 10-year yields would decline from 4.16% to 3.75% by November 18th (an event that had less than a 1% chance of paying off, but ultimately did pay off).

• All the while, institutions were bullish equities relative to retail traders—and the multi-week average of retail sentiment was more bearish than it had ever been.

Sure enough, the CPI report on November 10th came in much cooler than expected and equities exploded higher. The S&P 500 rose by as much as 7.7%, while the Nasdaq gained as much as 12% in the week after the CPI release. 

At that point, equities had moved pretty far, pretty fast, and were due to cool off. They did so by (generally) moving sideways the past two weeks (the S&P 500 is up about 75 bps over that time, while the Nasdaq is flattish).

We had expected a pullback this past week, but other than a moderate one on Monday, a pullback did not materialize. The rationale for a pullback was that the dollar and rates had fallen sharply and from a technical perspective looked poised to bounce (which would have likely caused risk assets to fall).

 Rates still look poised to bounce—the 30-year yield appears to be in a falling wedge pattern on the daily chart, while the 10-year yield is hugging the lower trendline of what may be a bull flag channel. 

The dollar does not look as bouncy as it did last week, but it may be double-bottoming near its 200-day moving average (similarly, the euro might be double-topping at its 200-day moving average).

Gold looks like it might be in a bull flag and set to move higher (continued weakness in the dollar or a decline in equities would support that thesis).

Equities are at or nearing resistance and thus at a crossroads. The Nasdaq has not been able to move past the downtrend line from the all-time highs (twice poking its head above the line in the past two weeks and twice being rejected). The S&P 500 is nearing its 200-day moving average (less than 0.7% away). 

Typically, we would not expect the S&P 500 to break through its 200-day moving average on the first try without some exogenous shock. But, we may have some data in the next week or two (e.g., the non-farm payrolls this Friday) that, if it were to come in “better” than expected, might be able to push the market through its resistance. 

If that were to happen, a swell of investors might be forced to chase the market higher—e.g., systematic trend-followers, as well as any underperforming managers who are sitting in cash. Couple this chasing with continued corporate buybacks into year-end and the potential energy exists for equities to overshoot what might be considered reasonable levels based on macro conditions and corporate fundamentals. 

One major hurdle for equities to clear resistance, however, will be Jerome Powell’s speech on the economy and labor market on Wednesday, November 30th. This speech will be two days before the Fed’s quiet period leading into their next meeting on December 14th. 

Unless the hawks at the Fed have had a change of heart recently (unlikely), we should probably expect Powell to do what he did at Jackson Hole, after the September FOMC meeting, and after the November FOMC meeting—attempt to jawbone equities lower. 

We say “attempt” because it’s not clear that his pronouncements will have the same effect as they had earlier—before inflation came in well below expectations and growth slowed dramatically. I.e., the market may continue to call the Fed’s bluff (egged on by favorable data and dovish FOMC members). 

For the entirety of this year, we’ve been viewing the market through the lens of “dollar and yields up/equities down,” and vice versa. These are the natural correlations at play when inflation is the market’s primary concern. 

While we think inflation, structurally, will be an ongoing concern for years, there could be periods where inflation ebbs as the primary concern and growth moves to the forefront. 

We might be in, or soon to be entering, one of those micro-periods. If so, we might see continued weakness in the dollar and yields and continued strength in gold (all because of recession fears), but rather than see continued strength in equities, we might see equities roll over.

Such a narrative-shift (and correlation-shift) would jibe with equities being up big off their mid-October lows but facing resistance (and VIX at support), with Powell looming and wanting to make an impression on equities before the Fed’s quiet period. It would also jibe with equities being priced to return less than bonds over the next decade (i.e., equities need to fall relative to bonds in order to be attractive). 

While a change in correlations would bring back a modicum of diversification to an equity-bond portfolio, equities would likely suffer so long as the market was gripped by recession fears. 

So far there is no indication of a change in correlations. Yields were down this past week, while the S&P 500 was up slightly. But it’s something to look out for, as it may catch investors offsides in their positioning. 

We don’t have a strong conviction as to which way equities will break in the coming weeks. 

A break higher would be consistent with investor positioning and technical considerations (e.g., to close gaps, revisit prior breakdown levels), while a break lower would be consistent with valuations still not being attractive and macro conditions being unfavorable. 

Weakening price momentum in equities (e.g., the S&P 500 made a higher high on Friday, but its RSI did not) as they near resistance with Powell speaking on Wednesday—that certainly appears like a recipe for lower prices in the near term.

Consequently, if equities do not break lower, it’s possible we end up seeing a melt-up instead, as speculators might be forced to cover their shorts and go long.

Institutions would likely be selling into any such rally—which would make sense given how much further afield equities would then be from any reasonable estimate of fair value. 

Let’s see how things play out.