MARKETS 

European equities were stronger Monday, Euro Stoxx50 up 0.9%, FTSE up 1.5%. US markets were closed for a holiday, although S& P futures edged higher with investors nibbling for bargains amongst the wreckage from last week’s nosedive from near decade-low exposure. But the sentiment was subdued as a bear market abounded.

And after a historic week for global central banks, policymakers will get to explain the reasoning behind their decisions this week. Top of the agenda will be Fed Chair Powell’s semi-annual testimony to Congress on Wednesday and Thursday.

And while the street does not expect Powell to reinvent the policy wheel, we could expect him to reinforce the idea that the FED is in data-dependent mode. Hence, any shift in Fed rhetoric will be a function of incoming data, virtually all of which now presents event risk. From that perspective, further evidence of persistent inflation will trigger policy panic, while any signs of sluggish growth momentum will confirm the recession narrative. Neither suggests that now is the time to board the rally wagon.

We expect the headline US CPI will accelerate +100-115 bp for June, driven by higher gas prices, which is driving monetary policy, locking in a 75 bp hike for July. The good news is the market is already close to pricing that in, so if you thought higher inflation was not in the price, think again.

The risk market’s last leg lower was met with capitulatory long selling in the energy space sending XLE -22% in less than 2wks. What started as trimming longs on talks of Russia/Ukraine resolution turned into a full-blown de-risking on growth fears and offside positioning.

As we said last week, the next leg lower in risk needs to come from a de-rating in earnings; using a 15-16x multiple, a 10% decline in EPS puts SPX 3200-3400; that would constitute a pretty significant recession, and we would need to see that play out in the data also.

So why are you not still mega short?

While the risk in equities is for an earning downgrade; however, the longer it takes for that to happen, the higher the SPX could tradeIt feels hard to bet on EPS lower now with SPX at 3700.

Making that bet at 4100 against a 25vol seemed reasonable given the length in the market at that time but making that bet at 3700 with a +30vol after a -23% drawdown YTD does not seem particularly exciting.

I am not saying we will not trade lower – we very well may. Still, if I were going to bring out the BIG SHORTS again, I would want to have a lot more confidence that the earnings deterioration is happening now and that the consumer has stopped spending; even then, I would make that bet from higher levels and closer to earnings season in mid-July.

And I think the big bears might be content to wait until after month/quarter-end when pensions will supposedly need to buy 82bn of Equities in the largest rebalance since March 2020 (which was 210bn) / 4th largest rebalance in over a decade.

OIL 

After getting hammered into the US long weekend due to recession and fuel demand destruction concerns, oil prices are rallying again. Those global economic worries are seemingly offset by prospects for higher US and China demand in the near term amid tight prompt supplies. The success of Shanghai mass testing, as measured by limited cases discovered, reinforces the idea that China will push on with a gradual reopening.

I think some folks in the US could be catching up to comments from  Energy Secretary Jennifer Granholm, who warned US drivers against quick relief in gasoline prices on the “continued upward pull on-demand” amid tight supplies.

Energy inflation remains a big concern as oil prices remain high and have not seen much of a move from OPEC/geopolitical developments that would suggest much relief. Politicians are getting creative, trying to find avenues to help assuage energy-driven inflationary pressures. Biden’s visit to Saudi Arabia and Germany’s newfound reliance on coal could dull the sharp edge of the oil rally.

China refineries have also cashed in on discounted Russian oil, which means more middle east crude for Europe. Oil imports from Russia increased 55%y/y and 25% m/m to 8.42m tonnes or 1.98mb/d in May as the refiners cashed in discounted supplies, Reuters reported, citing data from the Chinese General Administration of Customs.

OPEC is my most significant focus now. And I think all eyes will be on next month’s report on whether OPEC follows through with their agreement. But as importantly, will Biden’s Middle East bear some fruit in the form of more oil supply. But I am not sure how optimistic folks are, though, given OPEC’s recent track record.

 

–Stephen Innes

Managing Partner

SPI ASSET MANAGEMENT