They Only Care About Bond Yields....for Now

It is a head scratcher of a market.  Suddenly, over the past few days, the bond market has been on fire, as recession is getting priced in for 2023, along with a Fed dovish pivot.  Take a look at the Eurodollars future strip for the next 2 years:  

 

The market is now pricing an end to Fed rate hikes by December, with a Fed funds rate of 3.5-3.75%.  So 200 bps of hikes priced in for July, Sep, Oct, and Dec.  And then 40 bps of rate cuts in 2023.   The bond market is now pricing in a Fed pivot by year end. 

The stock market is loving the big drop in yields, as the STIRs is pricing in an end to Fed tightening by year end, mainly due to recession fears, from.... higher yields.  Apparently, the cure for higher yields is higher yields.  You cannot make this stuff up.  The stock market is conveniently skipping out on the recession is bad for earnings and going straight towards the Fed dovish pivot is good for valuations part of the story.  

Some may argue that SPX at 3800 prices in a recession, so a dovish pivot is good for stocks, even if a recession is a prerequisite for such a pivot.  If the SPX at 3800 in January 2021 was pricing in a huge economic boom with 10 year yields at 1.2%, how can it be considered reasonable to price the SPX at 3800 in June 2022 with 10 year yields at 3.1% going into a recession?  Dubious logic from Wall St., what's new.  

But in the short term, the market trades a lot on technicals and investor psychology.  After a huge drop from the end of March to now, you are getting oversold signals on an intermediate term time frame, while still being overvalued from a long term time frame.  The SPX is a notorious mean reverting instrument, so there are lots of countertrend rallies even in a bear market.  It's very possible that you get a bear market rally based on market hopes of a Fed pivot later this year as economic data comes in cool over the coming months.  I agree about the NFP and CPI coming in lower than expectations for the next few months, but the market is forgetting about the accompanying earnings misses that will come along at the same time.  

Investors are conveniently forgetting about earnings as its all Fed, all the time, but the weakness in the semiconductors over the past 3 months is a huge flashing red light about the state of the economy.  Semiconductors are the new Dr. Copper, as they are everywhere in the modern day manufacturing process.  People forget that technology is a very cyclical sector, sensitive to corporate spending plans and ad budgets.  In fact, I would argue that semiconductors are as sensitive, if not more sensitive to economic growth as oil and gas.  But people consider energy as a very cyclical sector, and tech as being more growth than cyclical.  But when technology is such a huge part of overall SPX earnings, and the market caps so big, they are the economy, not some specialized sector, less sensitive to the economic cycle.  

So we are in the middle innings of this bear market, very little capitulation, still hopes of a coming Fed pivot while they are still signaling multiple 50-75 bp hikes, and the ostrich head in sand behavior when it comes to forward earnings estimates.  I am open to a bear market rally that consolidates the steep drop over the last 3 months, recharge the bears, and then see another steep drop in the fall as the stock vigilantes come on board, selling off stocks to get the Fed to pivot towards a rate pause.  

Its been a painful selloff in energy stocks, even when the fundamentals are rock solid, you have PTSD from past energy stock bear markets that scare the crap out of the newer investors in the space.  Its a deep cleanse of positioning, getting rid of weak hands and shaking out the fast money hedge funds who were loading up on the momo train.  The strength in crack spreads and the products speak to strong demand even as you hear talks of demand destruction amid high prices and recession fears.  

My long term thesis for energy isn't based on the economic cycle, its just supply and demand.  In fact, the news flow over the past several days have been bullish for oil and gas, in particular Putin slowing down gas flows to Europe, which will incentivize gas to oil switching for power generation, as well as more long term LNG flows from the US to Europe.  Also the gas tax holiday just subsidizes gas consumption, which is the last thing this tight of a market needs, but politicians will always take the short term sugar high over the long term, more nuanced solution.  

Got a big gap up as we broke 3800 in overnight hours, the classic stealing the RTH move gap up.  I am neutral on SPX, its still feeling the afterglow of lower yields this week, and are at intermediate term oversold (way below a very downward sloping 50 day moving average) levels.  Don't know how long the bounce lasts, but if SPX can get close to the 4050-4100 area on what I expect to be weaker than expected econ. data in July, it will be worth a shot on the short side.