N | Trowbridge Capital

We hope you are having a great summer. Here is what we are looking at right as of Friday the 5th market close.

Post-Market Close August 5th

The soft landing thesis just got that much more difficult as the Powell Pivot is now in trouble after todays data. As we wrote in the pre-market a hot Non Farm Payroll and an increase in wage inflation (see below) would cause a selloff in the recent growth trade. As one would expect, this helped the value trade coupled with energy and financials today to rally. Does this mean it's the end of the Growth rally, not necessarily. However, it does lead us to believe CPI won't decline enough as consensus believes in the next print to keep the Powell Pivot alive. The market is now suggesting a 80% chance that the Fed will move .75bps in September from 30%.

A Binary Event

CPI is out this Wednesday and the market is looking for a potential .10 to .20bps decline in the headline number. While energy and some food costs have declined since July, if the headline number does not decline by at least .10 to around 9% and holds firm at 9.10%, technology is going to come under significant pressure and value stocks will get a significant bid. Conversely, if CPI does tick down .20bps to 8.90%, we believe a significant PEAK inflation rally will take the NASDAQ up to that 13,600 level. Thus once again rate expectation for September will decline back to .50bps.

More Importantly

More importantly than anything else we are watching the 2/10 inverted spread. As you know from our previous emails, it seemed this time around the spread was going to test -.48% last seen in 2001 and prior in 1998. Nothing good happened in the preceding months after the inverted spread had a blow off top. Even after a strong number the spread inverted an additional .059bps to -.41. This is possibly saying the bond market believes the Fed is going to have to push harder to slow down economic growth as the labor market is a beast.

How do we prepare for this? If investors are under weight value or have no allocation this certainly is one possible allocation for a reversion back into the value trade from growth. However, this might be just too short term tactical for many. We would expect Gold to now come under some pressure as todays job number was bullish for the dollar, however, its not worth reducing Gold exposure at this juncture if long. As for Dynamic Alpha, the strategy has very little exposure to growth and heavily tilted towards defensive stocks and some value. Today's number was positive for energy. However, unlike the setup back in December/January, demand destruction with crude oil is in play because of the potential for a hard landing growing based on the 2/10 spread and is just not an area we want to be overweight yet.

The S&P 500 has made tremendous progress and we still would be reducing risk at the levels we have discussed several times. One of my favorite proprietary metrics for the S&P 500 expansion is our Strong Buy to Strong Sell Ratio. These are our proprietary ratings for each stock. Back on June 21st there were 507 stocks within our universe that we considered strong sells vs 15 Strong Buys. Today we have 129 strong sells vs 120 strong buys. Historically, extreme readings in either direction with a rapid rate of change is a great set up for any reversion to the mean. Additionally, it is very bullish to see the green line of strong buys cross above the red strong sells.

Our S&P 500 model

Our S&P 500 model is now positive coming in at 0.28, which should not come to a surprise to readers. The moment of truth is approaching for the S&P 500 sooner than later. We have been raying the model could reach 15 before reversing.

U.S. Equity Positioning

While its impossible to know if this recent rally is just a bear market rally or potentially a breakout above 4,250 remains to be seen. However, our models above are not showing signs of slowing down yet in terms of positive price trends and momentum and rarely fail on the S&P 500 here. So far however, a large amount of this move has come from systematic traders (quants) covering shorts and assume hedge funds as well.

This chart provided by JPMorgan illustrates that every day for the past 2 weeks that the short covering was at extremes. This has been the largest de-grossing of shorts since March 2020. However, unlike the clear catalyst that sparked the recovery rally in 2020 that was supported by massive fiscal and monetary policy of around $6 trillion dollars, this time does not have one.

Fun Chart of the Day

Consumer Credit seen below measured and released by the Fed today saw a massive $40 billion increase. This is the second largest monthly spike in consumer credit in history. We can assume that since the consumer is trying to survive record high inflation, they are borrowing more to get by with less!!!

Source Feberalreserve.gov

Pre market Open August 5th:

75bps is back on the table for a September rate hike and its hard to argue CPI will come in much lighter now as a whopping NFP number hit this morning. WOW... almost a double in Nonfarm (NFP) payrolls, consensus was looking for 258k jobs vs actual 528k. The Fed will not like this, thus Tech & Growth will not either as rates will move higher. What a dichotomy weakening negative GDP with such a strong jobs market. To keep tech bid the market needed a weaker NFP today. The inverted yield curve on the 2/10 spread is now .-42bps almost at that historical -.48%. This is certainly worrisome to us.

Furthermore, we got a hot wage number that also will keep yield bid as well.

US July Average Hourly Earnings Rise 5.2%, smashing expectations of 4.9%
US July Average Hourly Earnings Rise 0.5% M/M; also beating estimates of 0.3%
US July Private Payrolls Increase 471,000; Est. 230k
US July Average Workweek at 34.6 Hours; Est 34.5
US Manufacturing Payrolls Rise 30,000 in July

We will be back after the close for our weekly market thoughts.

August 3rd

Price has changed, NOT the fundamentals or the economic backdrop. Price is a factor and more important than ever as more capital is being deployed within the quantitative and systematic investment space. These investors purely use price (Trend, Momentum, Mean Reversion and Statistics) in their models and not fundamentals. The bottom line is... we can all feel better with this rally, but the Powell Pivot was more of a reaction to extreme positioning and market participants will all follow each other like sheep.
Our S&P Model: As we stated:
- Our S&P 500 blended model was the 5th most oversold since 1998
- Rarely does the S&P 500 fail when the model is below a -60 followed by an increase. This has only occurred 2 times out of 18.
- We said a consecutive increase from below -60 could potentially take the reading to at least a 0 reading.
- Lastly, we said a +15.00 is where the S&P typically starts to lose its bullish trajectory if this is not a full V-shape recovery, which on average reaches a +65 reading. (Click on the image below to enlarge)

Our Upper Range S&P Target: We pointed out 4 weeks ago that the narrative of a Fed pivot was building as the most early cycle trade of semi's broke out. Regardless if this Powell Pivot is nonsense, the bond market bought in and our upper price target of 4,200 on the S&P 500 would be an opportunity to de-risk. However, 4,200 is not an area we look to sell growth, that would be around our upper NASDAQ (futures) target of 13,550/13,600. As we mentioned previously, a weekly close above 13,600 is a pivot move in this cycle that we don't believe is in the cards.
The Reversion: We can certainly see a blowoff short term top at 4,225 as shorts panic as the index moves above 4,200. If 4,225 was achieved on an intra-day basis where the index was up 50 to 70 handles, a key reversal will be in play. This would ultimately cause a retracement to 4,110.
Yield & Spreads: PEAK INVERSION of the 2/10 Treasury spread will be the ultimate tell. As we can reference from the chart below, once we experience a blowoff top in the 2/10 yield curve spread inversion, the S&P 500 corrects within the following months.
Both 1989 and 2001 yield curve spread inversions peaked at a -49% on the 2/10 spread and within 4 months the S&P 500 was down on average -13.50%. 2007 did not invert as much, only -.17%, although a similar retracement in the S&P 500 occurred around -15%.
It certainly seems like the 2/10 spread has the likelihood of inverting similarly to 1989 and 2001 at -.49% before peaking in this cycle and thus causing the markets to panic as economic contraction will not avoid the anticipated soft landing. Maybe this time will be different as there are only 4 data points of extreme inversion of the 2/10- spreads since 1989, which is not a large sample size for it to be extremally robust.

Dynamic Alpha

Dynamic Alpha is almost fully committed, however the portfolio is tilted to a more defensive position with staples and healthcare and lower beta exposure. As long as the market continues to price in peak CPI / Inflation and weaker GDP growth will most likely outperform. However, this positioning should allow for some upside participation and better downside protection at this current juncture of the market.