Market Forecast For the Week of May 1, 2023: The Fed Offers A Rope As The Bulls Move Further Out On A Limb

FORECAST: The S&P 500 rallies to 4210 and promptly reverses course as the bears make the case for a double top with the February highs. The bulls try countering that a mini-banking crisis failed to topple earnings or the American consumer but the bears take down that argument with the numbers within the numbers, which point to declining earnings quality and yet deeper declines in corporate fortunes. All the mentions of AI in CEO dissertations can’t mask the alarming deterioration of balance sheets, a mirror to the decline in political balance and sensibility across America.

My tally of earnings quality among the largest equities in the S&P is profoundly negative. It’s not earnings or the broader economy that have re-accelerated, but declining quality from the deeply bearish levels of the Summer and Autumn 2022. Inventories and credit are both piling up while GDP is turning down, with only the lagging indicators or inflation and employment left to crack. For the Fed neither are cracking fast enough, and this week will see yet another rate hike in the face of yet another bank failure, which the bulls believe must be undone soon in order to make the case for owning equities. So far the overwhelming majority of Fed governors have rejected that opinion.

Inflation expectations remain anchored to the 2-2.5% range over the next 5 years, which gives the bulls confidence that the Fed will soon see the light. But it’s complacency that worries the Fed, with the broader cultural and political trends of accelerating anomie and discontent fueling a decline in the work ethic that’s moving the staid and stolid Fed to vanquish wage inflation now, ensuring long-term price stability. That leaves the bulls at the mercy of monthly inflation reports. The odds are that disinflation in equity valuations happens sooner than wages and prices, as the bulls cease buying at high valuations and bears retake control of the mother of all bear market rallies.

My current positions include a very large cash position, 3M (MMM), Pfizer (PFE), the levered ETF UPRO and inverse levered ETF SPXU, all of which net out to a modestly long position in large-cap equities.