January 3, 2024 | Volatility

MARKETS

S&P 500: Down -19 points to 4724, VIX: 14.15

Asia: Japan closed, China +0.17%, Hong Kong -0.85%

Europe: Euro Stoxx 50 -1.65%, FTSE -0.67%, DAX -1.59% FX: USD (DXY) up 0.33%, EUR down 0.32%, GBP up 0.07%, JPY down 1.14%, CNY down 0.11% Energy: WTI Crude up 3.25% to $72.69, Brent up 3.10% to $78.21

Cross markets: Terminal rate unch at 5.33%, Implied rate cuts 2-years from terminal down ~10bp at 216bp, 5/10 yield spread +3bp Treasuries: 2-year yields up ~4.4bp at 4.364%, 10-year yields up ~6.4bp at 3.993%, 30-year yields up ~7bp at 4.14%

WHAT WE'RE THINKING

Snapshot: US equities are lower with the S&P 500 (SPX) on track to lose ground for a third straight session. Energy is the upside standout, while defensive groups outperform for a second day. ?Pharma, telecom and defense contractors lead, while autos, travel/leisure and solar stocks come for sale. December’s rate-sensitive winners like REITS and regional banks are notably weak, while mega-cap Tech is lower but holds up better than it did yesterday. Treasury yields are higher but off their intraday peak after 10-year yields crossed above 4% this morning. ?The Dollar Index is higher for a fourth-straight session. ?Gold and base metals are lower, while crude gains more than 3% on Middle East tensions and a Libyan supply disruption.?

·???????? Today’s data does little to shift the narrative with December manufacturing ISM coming in a bit better than expected but below November’s print and still deeply in contraction territory at 47.4. The prices component fell -4.7 points to 45.2, which helps the disinflation theme, but goods price disinflation has been evident for more than six months. Other components like employment and order backlog improved, while new orders ticked lower. The November JOLTS report was inline with consensus for ~8.8M job openings.

·???????? Fed minutes are due later this morning. Takeaways from the December FOMC meeting were notably dovish with the median ‘24 dot implying 75bp of rate cuts and Powell admitting the Fed has already started talking about dialing back policy restraint.

·???????? However, after the meeting a number of Fed officials pushed back on market expectations for near-term rate cuts. Just this morning, Richmond Fed President Barkin said the potential for additional rate hikes remains on the table as a soft landing is conceivable, but not inevitable.

·???????? After the release of Fed minutes, markets will turn attention to tomorrow’s weekly jobless claims data and Friday’s Jobs Report.

·???????? Investors also await updated inflation data from the Eurozone on Friday with consensus looking for December CPI to increase on a MoM basis. Reports today discuss the potential for incrementally higher inflation from recent geopolitical events including the rerouting of ships from the Red Sea.

·???????? China backs away from the strict video game regulatory proposals issued a few weeks ago as the government tries to repair market confidence. ?

·???????? It’s still quiet in terms of company-specific news flow. PSTG is higher on its announced inclusion in the S&P MidCap 400, and shares of SU rally after the company reported better-than-expected upstream production. XRX is a downside standout on an announced workforce reduction, while shares of SOFI and RKT trade lower after sell-side downgrades.

Chartist: The three-day pullback in the S&P 500 (SPX) and Russell 2000 (RTY) comes as both benchmarks approach broad range resistance. ?All major US equity indices are currently overbought and due for a period of consolidation in the 2-5% range, but overhead resistance has us considering the potential for a steeper pullback. Range resistance sits at ~4800 for the SPX and ~2045 for the RTY. ?Resumed leadership from the cyclically-sensitive RTY would be a bullish development for the broader market, but the buyers look lower for the time being. First line technical support for the SPX sits at 4605 (~4% from the recent peak) with stronger support at the breakout gap from 4411 (~7.9% from the peak). There are no signs yet of momentum divergence that tend to precede a bearish top, so we’d look for 4605 to hold for now.

Volatility: Greater near-term downside in equity markets would likely follow higher bond yields and increased bond market volatility. The MOVE Index that tracks bond market volatility has increased from ~115 to ~127 today with levels north of ~135 becoming a problem for the equity outlook. ?Realized equity volatility as measured by the VIX Index remains extremely subdued at ~13.60. ?While it's not a 1:1 ratio, increased bond market volatility will usually result in increased equity market volatility. ?VIX levels north of 22 are usually aligned with a bearish equity narrative and act as a headwind for rally attempts. ?

Rate expectations: The SPX is near all time highs with >200bp of rate cuts priced into the forward curve. ?It’s logical to assume that downside risk for the SPX would come from an upward shift in rate expectations. Fed minutes were released moments ago and mostly confirm what’s presently priced in the OIS market. The December Jobs Report on Friday is the next catalyst that could change market rate expectations.

FACT OF THE DAY

On July 2, 1982, Larry Walters attempted to fly 300 miles into the Mojave Desert by strapping weather balloons to a lawn chair. ?At 16,000 feet, Larry was spotted by two different commercial pilots, who alerted air traffic controllers about ‘what appeared to be an unprotected man floating through the sky in a chair.’ Larry’s flight started ahead of plan when the line he attached to his jeep broke prematurely. ?Apparently, his ascent to 16,000 feet was ‘rapid’ and took him by surprise. Fortunately, Larry aka ‘Lawnchair Larry’ brought sandwiches, beer, a camera and a pellet gun. ?Shortly after being spotted by the commercial pilots, Larry shot down some balloons, which allowed for a gradual, but uncontrolled descent that ended up breaking a power line and causing a 20-minute electricity blackout. Larry was initially fined $4,000, but it was later reduced to $1,500. ?Pictured below shortly after takeoff.

WHAT WE'RE DOING

When does bad news become bad again? A meaningful slowdown in job creation over the coming months would likely flip the ‘bad-news-is-good’ for equities script. ?Pricing in an economic slowdown or recession would weigh on deep cyclical and small cap stock valuations, making for an attractive entry point. Read on CNBC

Money Life: Andrew speaks with Chuck Jaffe about the emerging Goldilocks theme, AI beneficiaries and a lightening round featuring APD, MRO, AMT and C. Listen to the Market Call at 32:33

Alphabet stock falls after cloud revenue misses: Speaking on an earnings panel, Andrew discusses key takeaways from Alphabet’s Q3’23 earnings report. He highlights pressure on the NYSE FANG+ Index with overcrowding in Magnificent Seven names like GOOGL. Watch on Schwab Network

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THIS DAY IN HISTORY

January 3, 1987: Aretha Franklin becomes the first woman inducted in the Rock and Roll Hall of Fame. The Hall of Fame’s first group in 1986 included musical legends Chuck Berry, Elvis Presley, James Brown, and Ray Charles.

CATALYST CALENDAR

Tomorrow: 1) US ADP jobs report for December; 2) US weekly jobless claims; 3) Germany’s regional CPIs for December; 4) France’s CPI for December; 5) Eurozone services PMI for December; 6) Hong Kong’s retail sales for November; 7) Earnings before the open: CAG, LMN, LW, RDUS, RPM, SMPL, WBA

Friday: 1) US jobs report for December; 2) Eurozone PPI for November; 3) Eurozone CPI for December; 4) US services ISM for December; 5) US factory/durable good orders for November; 6) Taiwan’s CPI for December; 7) Earnings before the open: STZ

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?This material is intended for informational purposes only. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor.