Does the equity rebound have legs?
It’s probably time we stop asking that in favor of asking whether the rally is exhausted.
On the heels of a second relatively benign read on US inflation in as many sessions, the S&P was 15% off the June lows, and big-cap tech 21%.
Post-PPI gains fizzled, and were anyway uninspired compared to the ebullient reaction to July’s CPI report, but that was to be expected. The point is just that with tech shares arguing for a new bull designation (figure below), and the S&P gunning for a fourth consecutive weekly gain, the longest streak since November, it’s safe to say the bounce had legs. And it ran.
The question now is whether the rally is done or if conditions are such that equities can make a run at meaningfully higher levels.
It seems ludicrous to suggest the S&P can reclaim January’s record, but in a testament to shifting winds, Bloomberg’s “question of the day” for terminal users was just that.
“How long will it take for the momentum from cooling US inflation data to drive equities back toward the peak?” Mark Cranfield wondered on Thursday, from Singapore. “Or will the rally falter if the Fed continues to target 4% rates?”
The simple figure (below) shows the drawdown morphing into a draw-up.
Plainly, the cooler-than-anticipated CPI and PPI prints were a welcome development and I suppose you could even argue that Fed officials’ effort to push back against the “dovish pivot” narrative is itself bullish to the extent it demonstrates a commitment to restoring price stability, thereby further reducing the risk of a nightmare inflation spiral.
I’d look for Fed speakers to lean in further, though. It seems very unlikely that the Fed would countenance stocks making a run at record highs given the read-through for financial conditions and the extent to which a reinvigorated wealth effect could prolong and exacerbate whatever portion of America’s inflation problem is attributable to “too much demand.”
And yet, as we learned while watching equities sprint higher following July’s CPI report, there isn’t a lot the Fed can do to dissuade stocks on any given day, and perhaps not during any given week or month either, absent an inter-meeting rate hike, which would be difficult to explain in the absence of an unfavorable development on the inflation front. There’s no chance of the Fed hiking rates between meetings “because stocks are hot” — as funny as that’d be.
Perhaps more importantly in the very near-term, there’s a setup for more gains. “I feel confident that the lows for equities and the highs for yields have already been made in June, particularly looking at equities sentiment and positioning,” Nomura’s Charlie McElligott said, in a Thursday note.
The rally, he suggested, has “some further room to continue running, just on mechanical rebalancing and fundamental ‘force-in’ alone,” he added, on the way to reiterating key points from last week.
“The S&P 4,200 level [was] a potential ‘short Gamma’ launch point on a breakthrough, as there were some lumpy call spreads which traded in the market over the past few months where clients were short that as their upper strike,” Charlie wrote, before flagging key technical thresholds at 4,215 in Spooz and, of course, the psychologically important 200-day moving average (figure below).
He also noted heavy overhead strikes at 4,250 and 4,300 and the prospect of additional positive delta flows as puts decay and melt away into the summer spot rally.
Meanwhile, three-month realized is slowly catching down as “wild” days fall out of the sample (figure below). On a one-year lookback, three-month was perched in the 100%ile until very recently, but has since receded to the 76%ile, with more to go.
That’s conducive to re-allocation flows from the vol control crowd. Assuming a +/- 1% daily distribution for the S&P, Nomura’s model projects a bid in excess of $22 billion over the next month.
If stocks were to settle into an even quieter range (i.e., 0.5% daily changes), the re-allocation flows could be considerably larger.
The icing on the cake would be CTAs flipping “max” long. We’re still well below levels that would trigger the next wave of trend re-leveraging on Nomura’s model for the Nasdaq 100 and US small-caps, but the level to hit for the S&P was a very attainable 4,339 as of Thursday.
Of course, none of this means the macro outlook is suddenly sunny, or that inflation, having (possibly) peaked, is now a one-way ticket lower. We’re not in Kansas anymore. Macro vol, I’d venture, is here to stay.
But stocks will be stocks. For better or worse.