In Search of a Bullish Narrative

The S&P 500 broke a four-day losing streak in a volatile session on Thursday. Opening strength was aggressively sold, but stocks reversed at midday and managed small gains on about two to one positive breadth.

The volatility continues here on Friday morning as market players await significant economic data as well as comments from no fewer than five Fed members. Loretta Mester, Philip Jefferson, James Bullard, Christopher Walter and Susan Collins are all set to speak at various times between 10 am ET and 1.30 pm ET. 

Before the market opens, we will see the Personal Consumption Expenditures (PCE) data for January. There is particular concern that core services PCE, which excludes shelter, will be hotter than expected due to price increases in areas such as airfares and medical insurance. We also have personal spending, new home sales and University of Michigan consumer sentiment numbers on tap. 

The problem the market faces currently is that the bulls have lost their narrative, which helped to drive substantial gains to start the year. The narrative was driven in large part by positive price action caused by poor positioning, short squeezes, the January Effect and other structural issues. The bulls argued that the price action was justified because inflation had peaked, the Fed was likely to make a dovish pivot and the economy was strong enough to avoid a recession. In other words, it was a Goldilocks economic environment where inflation was not too hot and economic growth was not too cool. 

The bears were very skeptical of this narrative, but they were crushed by the positive action. The market ignored hotter-than-expected Consumer Price Index, Producer Price Index and employment news and was not perturbed by hawkish comments from Chairman Jerome Powell or the Fed.

Things finally turned a little over a week ago as the odds of interest rate hikes at the next three Fed meetings started to rise and a couple Fed members talked about the potential for another one-half percentage point hike. The minutes of the last Fed meeting confirmed that there was more hawkishness than the market seemed to indicate. Even the latest GDP report showed that the fourth quarter data had understated inflationary pressures. 

With rates rising and the Fed making hawkish comments, the bulls lost their narrative. The price action turned and the Goldilocks argument has fallen apart.

Some bulls are now arguing that the rate hikes and the Fed’s hawkishness were already well-anticipated and have largely been discounted, but that is a tough sell given valuations and earnings reports as we saw from Home Depot (HD) and Walmart (WMT) . 

The S&P 500 is still holding above its 50-day simple moving average but looks quite precarious. The market is expecting a hot PCE report, but the big issue will be whether it impacts the likelihood of a 50-basis-point hike at the next Fed meeting in March. 

The bulls need a new narrative very quickly. Either data must improve or the market needs to believe that we already have discounted the economic chaos that lies ahead.