SUMMARY
Current market conditions may present an attractive entry point and supports our equities stance
Key Takeaways:
Purchasing managers' surveys and high-frequency data point to continued solid growth.
The fundamental backdrop for bond duration remains poor despite the recent rally.
Positioning and sentiment, rather than fundamentals, drove recent market moves.
An S&P 500 "fear" reading we reference historically now shows potentially strong equity returns.
Preliminary October PMI readings point to growth in most major economies.
Growth holds firm as the U.S. pulls away
Recent economic data paints a picture of solid global growth. October flash Purchasing Managers' Indices (PMIs) showed the economies of the U.S., Spain, Japan, China, Germany, the UK, and Italy in expansion territory on both a three- and six-month basis. The U.S. leads the pack, posting composite readings at levels we last saw as the economy emerged from the COVID pandemic[1].
High-frequency U.S. data reinforce the message. Jobless claims remain low, and private payroll data look healthy. Redbook same-store sales rose 9% year over year as of mid-October, a pace that suggests consumers continue to spend through inflationary pressures.
In our view, this macro backdrop remains supportive of equity risk. Earnings season has delivered strong results so far, and about 40% of the S&P 500 companies report this week, which should sharpen our read on fundamentals.
BOTTOM LINE: Purchasing managers' surveys and high-frequency data point to continued solid growth, particularly in the U.S. We believe the macro and fundamental picture continues to support our stance.
Inflation data undercuts the disinflation narrative
Our view that inflation will remain sticky sits outside consensus. Many forecasters expect price growth to moderate on two assumptions: a fading tariff impulse and lower energy prices. We view both as speculative. If tariffs ease and energy prices fall, the backdrop may improve, but the incoming data align far more closely with our view that inflation remains elevated.
Business surveys show little relief. PMI output price measures remain broadly elevated across major western economies. Several regions saw modest improvement in September and October, but not the U.S., where output prices reached a four-year high.
Price pressures also run broad and deep. As of September, 44% of the Consumer Price Index (CPI) components we track rose at annualized rates of 5% or more, one of the highest readings in four years. Producer price data show pressure building in the pipeline: Unprocessed goods prices rose nearly 25% year over year, processed goods 8.5%, and finished goods 4%. We expect those upstream pressures to push finished goods prices higher.
Markets lean strongly toward a U.S. Federal Reserve (Fed) hold this week, pricing roughly 10% odds of a hike. We do not predict a hike, but we believe the case for one is strong. More broadly, we expect central banks to keep raising rates while inflation remains above target.
Bonds have rallied, but we believe the fundamental backdrop for duration remains poor. Strong growth, high inflation, and fiscal concerns all weigh on the case for longer-dated bonds.
BOTTOM LINE: Forecasts of slower price growth and less policy tightening than markets price appear to rest on hope rather than data. Despite the recent rally, we believe the fundamental backdrop for bond duration remains poor.
Fear readings set a constructive stage for equities
Our investment framework rests on four pillars: macroeconomics, fundamentals, positioning and sentiment, and valuation. While macro and fundamentals look solid, positioning and sentiment have driven much of the recent market action.
The Treasury rally offers a clear example. As equities moved into risk-off mode, the traditional stock-bond correlation reasserted itself, and yields fell. Speculative positioning in 10-year Treasury futures and options sat at bearish extremes, so short covering likely exaggerated the move.
On the equity side, an S&P 500 sentiment and positioning indicator we reference recorded a second consecutive weekly fear reading on October 23 (Figure 2). These readings have historically identified entry points for the S&P 500. The signal has proven most compelling 18-to-20 weeks out; and at 19 weeks, stocks have risen more than 90% of the time with an average return of 10%.
Seasonality adds context. Four of nine episodes of consecutive fear readings occurred in October, and three of those four October episodes came in midterm election years.
Despite some skittishness in markets, we believe the data backs our current stance. In our view, that skittishness has created a sentiment backdrop that has historically been followed by strong returns.
BOTTOM LINE: Positioning and sentiment, rather than fundamentals, drove recent market moves. A sentiment indicator we reference recorded a second consecutive weekly fear reading, a backdrop that has historically preceded strong equity returns.
[1] The COVID-19 pandemic began in late 2019 and officially transitioned out of the global emergency phase in May 2023.
