Fundamental forecast for the S&P 500: bearish
Globally, equities seem to be in a generally optimistic position.
There may be some measure of seasonal influence at play in this stance or a lot of speculative appetite; but in many instances, it is increasingly conflicting with the tangible fundamental outlook.
The IMF kicked off 2023 with a warning that a third of the world’s economies are facing a recession this year; and for many of those not in a technical contraction, it will feel like one. It is likely that the markets have become conditioned over the past decade to dismiss natural economic and financial troubles owing the outsized influence of the world’s central banks. Through much of recent history, these major institutions have stepped in with stimulus even when there wasn’t a tangible economic concern but merely the sign of a market tantrum.
Yet, with the extraordinary inflation levels of the past year and risk of embedded higher prices for the future (it doesn’t have to be at the extremes); there is little chance that the authorities are still the reliable backstop they once were.
When it comes to setting expectations straight on what central banks will and will not do, there has been no more transparent a group than the Federal Reserve. They have reiterated their stance that rates in 2023 will peak at consensus of 5.1 percent and no cuts will be realized before year’s end. The market has constantly discounted that view.
After the December employment report this past week, the rate forecast for June (the loose terminal time frame) ebbed with a notable boost for the S&P 500. What is far more remarkable though is that the slump in the ISM service sector survey (49.6) – which is a strong proxy for the broader economy – furthered the Friday bounce on a small change in rate forecasts.
That is remarkable considering it significantly raises the onus of a recession and everything that means for the markets.
Ultimately, this index is still carving out an extraordinarily narrow range as a carry over of seasonal conditions and is in the middle of its range and the Dow is near multi-month highs and the Nasdaq 100 on the verge of fresh multi-year lows. The common factor is the extremely low level of expected volatility.
Below, I overlaid (an inverted) VVIX Index. This is a volatility of volatility measure that is a better measure of complacency than the standard VIX. It has pushed to lows not seen since March 2017. That is extreme and carries a meaningful directional influence.