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deGraaf: SPX Is Set to Melt Up

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Updated

SPX melt-up risk

I wanted to flag the prospects of SPX melt-up risk, which we think are very real, and make the case in four and a half charts. Given the good economic data (chart 1), loose credit conditions (chart 2), benign inflation data (chart 3), and investor sentiment (chart 4), we think the risks of the Fed (and G7 central banks) blowing an asset bubble are above average.

Seasonality remains firm despite the impressive S&P returns YTD (year-to-date), and momentum tends to perform well in the fourth quarter. Many of these indicators are “too good,” but until credit conditions deteriorate, we’re holding on to this tiger’s tail.

1) PMI readings are only important 20% of the time and at extremes (direction doesn’t matter much). We are now in the only zone where forward returns on SPX are negative (and statistically significant). PMI > 60 = SPX seller 12-month forward.

1a) Our system shows points over the last 50 plus years where PMIs were in this decile:

2) This is happening while inflation data (Fed’s focus) remains in the lower quartile of historical readings (keeping them lower longer):

3) Inflation keeps credit conditions very loose (80th percentile), and it’s not just the Fed, G7 Weighted CB balance sheets are growing 8% YoY:

4) Given this volatile combination of a hot economy and loose credit, the question is whether investors are positioned for a melt-up scenario. We don’t see that yet:

RenMac: Analyzing macro factors that impact the investment world.

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