JPMorgan’s Marko Kolanovic sees evidence of “dissonance.”

Markets steadfastly refuse to give up on the notion of Fed cuts commencing in the back half of the year. Risk assets, liking the idea of a quick pivot to easing following the most aggressive tightening cycle in a generation, are accordingly buoyant. And yet, Fed officials are adamant that the odds of rate cuts in 2023 are quite low given inflation realities and, at least for now, a resilient labor market.

For Kolanovic, that’s an awkward conjuncture that probably isn’t sustainable. “What equity (and more broadly risk) markets refuse to acknowledge is that if rate cuts happen this year, it will either be because of the onset of a recession or a significant crisis in financial markets,” he said Monday.

In all cases (in a recession, certainly in an outright calamity or, in the absence of either, in a “higher for longer” scenario), stocks would presumably suffer.

Remember: Rate cut pricing is arguably more about the left-tail risk+ from banking stress than it is about anything else. In February, a string of upbeat macro data and, on the eve of SVB’s collapse, hawkish testimony from Jerome Powell on Capitol Hill, finally succeeded in squeezing out 2023 rate cut bets. The bank failures rekindled them.

By now, the figure above may feel a bit “tired” to regular readers who’ve seen it over and over, but there’s no better way to capture what’s happened since Powell told US lawmakers that rates may need to go higher than the Fed previously believed. 48 hours after he hinted (unsubtly) at a higher terminal rate, SVB imploded and in short order, so too did terminal rate pricing.

As Kolanovic noted, this feels a bit tenuous. If the worst-case materializes vis-à-vis the banking system, equities would surely crumble. The same goes for some manner of CRE-related meltdown. If not, then the impetus for the rate cut bets disappears, rates stay elevated and stretched valuations are vulnerable again as bonds stay under pressure.

That’s all the more true given that a disproportionate share of 2023’s stock rally is attributable to rate-sensitive growth stocks, a dynamic which pushed key measures of market breadth into “red alert” territory, if readers will forgive the lapse into colloquialisms.

The simple figure above (another recycled chart) tells the story. This is a narrow market.

There are any number of ways to illustrate that point too, but all you really need to know is that five stocks account for almost all of this year’s US equity rally. When you expand the list to include Tesla and Nvidia, you capture the entirety of the rally — and then some.

“The gap between the bond market, equity market and the Fed is likely to close at the expense of equities [as] higher rates means lower multiples (and higher risk of recession) and lower rates would most likely be a result of a risk-off event,” Kolanovic went on to say, adding that “equity market breadth by some measures is the weakest ever, with the narrowest stock leadership in an up market since the 1990s.”