Market Forecast For the Week of May 22, 2023: The Bulls Reckon With Ceilings That Fall Lower And Lower

FORECAST: The S&P 500 consolidates last week’s runup to resistance before beginning another leg up in this the mother of all bear market rallies. The conclusion to this week’s consolidation will be a small month-end rally to higher resistance at 4300, which will mark the end of the most bizarre pain trade in years. Earnings are the superficial reason the bulls have wrested control and waiting to take the market higher, but deeper analysis of the poor quality of earnings is what will sap the bulls’ confidence and mark the return of the bear, taking the S&P down to the October lows and likely far beyond them.

Global investors are betting on lower global growth over the next 12 months followed by robust growth for the remainder of the decade, making mega-cap stocks the place to park funds in the near-term. This is delusional and rests on the notion all will be well as pre-pandemic trends magically reassert themselves after 2023. Low equity trading volume and illiquidity in bond trading reflects low confidence in this delusion, but the bears have yet to highlight the decline in earnings quality and so have no new arguments to wrest control back. Fully digesting earnings reports is what investors do and once done they will revert to selling, recognizing that even for the mega-caps things are going to get much worse before any substantive hypothesis about the long run can be made with confidence.

For now however it’s the macro argument winning the day. The action across fixed income, currencies and commodities reveals that investors believe global inflation and growth will soon decline precipitously and set the stage for central bank easing across the world. This naturally powers US mega-cap stocks, but the rest of the equity market suffers from earnings uncertainty due to negative geopolitical and cultural trends, the lags of monetary policy, moves to fiscal retraction, deglobalization via nearshoring, the strange revolution that is AI and a weak China reopening among other things. Consequently breadth is low and the bifurcated market means US valuations are rising and in turn lifting global bourses that trade at lower valuations. And just as most equities are treading water so too credit spreads are similarly subdued, reflecting confidence in firms as going concerns, even if zombies from the perspective of returns on equity.

Besides unhealthy breadth and poor earnings quality the market will have to come to grips with declining productivity and increasing statism that are ruinous to earnings. AI cannot generate productivity gains in the intermediate-term — forget about the near-term — since costly monitoring of this unpredictable source of labor will have to be undertaken while simultaneously regulators and politicians cook up new ways to raise the costs of doing business and encroach the state onto society. Existing productivity trends are poor and the demographic problem underlying the debt-ceiling debate cannot be reversed. As the market coils higher with investors selecting fewer and fewer equities a pop is inevitable.

On Friday I sold a portion of my position in the leveraged ETF UPRO and increased the position in the inverse levered ETF SPXU. Consequently my current positions include a large cash position, 3M (MMM), Pfizer (PFE), the levered ETF UPRO and inverse levered ETF SPXU, all of which net out to a neutral position in equities.