Following last week’s big Fed pivot/cooling labor market fueled risk asset rally, the big question entering this week was can that momentum be sustained. We’re two days into the week and the results, so far, looked fairly mixed. Small-caps have gone back to lagging large-caps and junk bonds have given back some of their outperformance relative to Treasuries. When looking back at the past week and a half as a whole, this kind of looks like a lift for equity prices in general, as opposed to a big risk-on trade. Big tech, speculative tech and growth stocks have outperformed, as might be expected, but high small-caps and high beta have really only matched the S&P 500 and utilities have held up fairly well. We’ll see if those trends continue as we head into the tail end of the world, but those now banking on a soft landing or the next big bull run might want to pump the brakes a bit.
On the other hand, the lumber/gold ratio is starting to pick up steam again. This is a bit of a tricky one to interpret because the short-term and intermediate-term signals are essentially reversing from what we saw just a few weeks ago. The utilities signal is still risk-off and Treasuries are rallying and holding on to those gains. That would suggest caution in the near-term, but if lumber/gold is turning higher again, that could indicate that investors may be starting to buy into the idea that a soft landing might be possible after all. If you consider the macro backdrop where home construction demand is falling quickly and high mortgage rates are contributing to a larger credit contraction, there’s not really much support for a big lumber rally here. I think if you take all of the intermarket signals together here - lumber, gold, utilities, tech, Treasuries, small-caps - this starts to look a lot like a relief rally without a long-term future. If Treasuries continue to push higher this week, I think we have to conclude that the flight to safety trade isn’t dead and this is another likely bear market rally.
With respect to the credit market, the latest quarterly SLOOS survey from the Fed pretty much confirms what we already know. The credit contraction is already here and the lagged effects of it will continue to be felt over the next several months and beyond. Optimists will point out that the number of respondents saying that they’re tightening standards for C&I loans fell from the previous quarter, but the net number of loan officers reporting tighter conditions still far exceeds those being more willing to lend right now. This trend, at least according to the survey, has been in place since late 2021 and is actually in worse shape today than it was during the depths of the COVID pandemic. Perhaps more concerning is the fact that, while lending conditions improved for larger lenders, the net number of smaller lenders tightening their standards actually got larger. This probably shouldn’t be surprising given that small banks are disproportionately more heavily involved in the commercial lending space and their reluctance to loan money in this environment is a sign that conditions for a major credit event are still high.
In total, I think that the notion of a more neutral Fed and a cooling job market is what investors have wanted to hear for the past year if not longer. That’ll suck the bulls back in for now, but the longer-term deteriorating economic outlook will likely eventually take over.
Keep reading with a 7-day free trial
Subscribe to The Lead-Lag Report to keep reading this post and get 7 days of free access to the full post archives.