Week Ahead on Wall Street (SPY) (QQQ): Inflation and bond market yields hold the keys to this rally

• S&P (SPY) closes up over 4% on the week.
• Nasdaq (QQQ) closed with a gain of 4.5% versus a week ago.
• Dollar loses its grip on power as Yen and Euro rally.

A huge week in data terms. The Fed pushed rates higher by 75 basis points and everyone cheered. Equity markets rallied sharply, a curious statement but there you go. We did note that the previous 75 basis point hike in June was met with a sharp sell-off so why the difference this time? Well as we often say the market decides what it wants to do and then shapes the narrative around that outcome. We were told the Fed had turned all dovish because the market wanted and needed to rally. That was the path of least resistance and maximum pain to investors. The Fed merely abandoned guidance it didn't really get all lovey-dovey. 

US GDP then came and added to the dovishness. Again more bad news, the US is in recession, but the equity market immediately begins to rally on this so-called bad news. Why? Because it wanted to. Bond yields falling helped high-risk sectors move higher and from there the only hurdle left was earnings. But Apple and Amazon both held up their end of the bargain and so here we are at the end of the week some 5% higher. Right or wrong, you decide. Currently, the market is pricing in a very optimistic setup in our view. Inflation falling from nearly 9% to 3% in 18 months is unprecedented and quite frankly highly unlikely in our view. We are not alone in our view and have some good company!

But don't fight the Fed and the flow is the mantra to live by so rally on dudes!

Earnings season is now over the hump with big tech, banks, and oil majors out of the way. That leaves the smaller fish to come which should not upset the bullish apple cart too much. We expect volatility to remain high though as the bond market looks to work out exactly where it should be pricing year-end rates. Bond volatility means equity vols will remain elevated so expect more large PnL swings. But we all got a bit too pessimistic about this earnings season, your author included. We did not get the washout low that many were expecting. Maybe it comes in Q3 or maybe it does not come at all. But already Wall Street has pared 2023 consensus S&P 500 EPS from $250 to $243 during earnings season. Sticking a current forward P/E of 17 here means a move from 4,250 to 4,131 for forward S&P forecasts. Small but steady and likely more to come.

 

We have noted how underweight the latest fund manager surveys are along with the low sentiment from the AAII and Bull and bear surveys. All this has meant the rally was set up. Fund managers and especially hedge funds need a strong quarter and H2 to stem redemptions in the second half of the year. They will bet big on beaten-down tech names and no surprise to note this is already happening.

Adding to the rally has been the flip from trend following CTA programs that have closed short bets.

 

The only chart that matters going forward though is this one, fed funds futures for Dec 2022 (bar chart) and Dec 2023 (line). Currently pricing in aggressive rate cuts in 2023. Optimistic. If this changes equities will quickly reprice. If the spread narrows and or either goes up then it is time to exit risk.

Earnings highlight

AMC earnings preview

We know you all like this one and certainly, we can expect some good soundbites from CEO Adam Aron to his AMC apes. Footfall remains good with the summer blockbuster season going well so that should lead to an upbeat report and strong revenues. The problems are further down the road but with financial conditions easing expect more risky assets to rally so that tees up AMC next week.

Monday has PINS and ATVI earnings. Tuesday AMD and PYPL, Wednesday Lucid and Moderna, and Thursday AMC.

SPY forecast

The gap to $401 has finally been filled and $415 now beckons. Volume begins to increase up there so this move may begin to slow but we remain bullish. 

SPY daily

Economic releases

There is not too much data to disturb this rally until perhaps Friday's employment report. The most recent weekly jobless claims data is beginning to show signs of the jobs market slowing but last month's employment report was strong. This is no surprise as companies finally catch up with filling vacancies and pent up demand cools so slowing employment growth. Expect the employment market to slow into year end.