Research Notes

Strategy

• Short-term momentum in Technology and Industrials closed Wednesday in the 1st percentile of history dating back to 1985, marking one of the swiftest and largest momentum unwinds on record.
  • With 61% of cap goods and 37% of semis making 20-day lows, oversold conditions warrant a bounce, but don't mistake a bounce for the end of the unwind.
  • The AI trade is shifting from an "everyone wins" environment to one where the market has to separate the actual winners from the losers.
  • Expect momentum to become less dominant: some former laggards will emerge through breakouts, while some former laggards will become losers through breakdowns.
• Consensus Inc bullish sentiment is back in its upper decile, but historically the signal has only a 12% win rate, making it a poor standalone reason to turn bearish.
  • The statistics look better than the actual outcomes. With odds that poor, the signal is statistically interesting but practically difficult to trade.
  • What matters more is the synchronization: ETF flows, COT data, and other sentiment surveys are also showing elevated optimism.
  • Sentiment works best when "everyone" is thinking the same way. We're unimpressed by the individual signal, but increasingly mindful of what the aggregate is telling us.
• Crude has broken through the downtrend that capped every rally since February, while 2-year and 10-year yields have simultaneously broken to new highs.
  • The move pushed our Yield Impact Model to the 100th percentile, historically a notable headwind for equities over the next quarter.
  • The risk/reward is becoming less compelling: investors are being asked to hold equities over T-bills while the Market Cycle Clock sits in a zone where the S&P has annualized just 0.56% vs 9.03% historically.
  • Put simply, the pot is increasingly leaning against the cards in our hand.
• The 2-year yield remains the key variable, with markets now leaning toward a Fed hike and our Yield Impact Model continuing to signal a meaningful headwind for equities.
  • Credit remains the arbiter: tight BBB spreads keep us long, but a decisive widening would force a reassessment.
  • Positioning is increasingly crowded across ETF flows, large speculators, and small NDX traders reinforcing the message to buy oversold leadership rather than chase index strength.
  • Watch deGraaf video

Economics

• The labor market strengthened meaningfully in August, with payrolls up 162k, prior months revised higher, and the three-month average improving to 71k.
  • The underlying details were stronger than the headline: hours worked increased, wages rose 0.3%, hiring breadth improved, and involuntary part-time employment fell sharply.
  • Private demand remains solid, particularly in goods production, with construction adding 22k jobs and manufacturing 16k as factory hiring continues to broaden.
  • Stronger hours worked leave less room for productivity growth, potentially keeping pressure on unit costs and inflation.
  • The household survey also showed diminishing slack, with employment up 569k, participation rising, and more workers voluntarily leaving jobs.
  • The report weakens the case for the Fed doves. With inflation already above target and the labor market reviving, there is little labor-market justification for delaying a hike.
• Waller is leaning toward a September hold, but next week's CPI is the swing factor. With policy only mildly restrictive, a hot print could quickly put a hike back on the table.
  • Despite recent inflation improvement, Waller still sounds one bad inflation print away from tightening, leaving the bar for a hike relatively low.
  • The Fed's shifting rhetoric lacks a clear explanation for why inflation should slow on its own, particularly with AI capex, tariffs, and the Middle East conflict and financial conditions still posing upside risks.
• Services activity accelerated in August, with the ISM Services PMI rising to 55.4, driven by the strongest business activity and new orders readings in several years.
  • Hiring isn't following the growth signal, with employment remaining in contraction at 47.8. Stronger output without additional labor points toward improving productivity.
  • Prices are the bigger concern: prices paid jumped to 72.6, the highest since August 2022, as tariffs and Middle East disruptions continue to pressure costs.
• Manufacturing expanded for an eighth straight month, with the ISM at 54.6 and production remaining strong at 58.3, consistent with roughly 2.4% real GDP growth.
  • Forward-looking demand softened, with new orders, backlogs and employment all declining, though low customer inventories remain supportive of future production.
  • Cost pressures remain elevated, with prices paid at 71.1 as tariffs, higher energy costs and AI-related component shortages continue to pressure manufacturers.
• Construction spending fell 0.5% in July and 3.8% YoY, led by continued housing weakness as residential outlays declined for a fifth straight month.
  
  • AI remains the major exception, with data center construction surging 57.2% YoY, while factory construction has fallen 21.7%.
  • The housing downturn is increasingly a labor-market story, with weaker residential spending pointing toward a rollover in construction employment in the months ahead.

Research Notes

Economics

• US labor market continues its downtrend. Weekly job postings continue to trend down, layoffs picking up, quits are cooling.
  
  
• March data showed broad economic weakness, with declines in services, confidence, housing, and commercial real estate.
  
  
• Rising inflation, weakening job outlooks, and cautious business spending point to growing economic strain.
  
  
• Home prices are cooling, which may curb spending as household wealth dips and the savings rate edges higher.
  
  
• The rebound in capital goods shipments looks fragile, with growth mostly tied to tech and broader investment plans weakening.
  
  
• New tariffs could cut 0.5% from GDP, strain trade ties, and raise car prices before production shifts take effect.
  
  
• Auto repossessions are at their highest since 2009, and tariffs may push buyers to the used market, keeping prices elevated.
  
  
• Despite trade tensions, signs of de-escalation and strong profits offer some cushion, with markets already pricing in much of the downside.
  
  
• Q4 growth was lifted by consumer and government spending, but with investment falling and key supports fading, a broader slowdown seems likely.

Strategy

• Market technicals show potential for a rebound. We think Mag7 approaches 50dma and potentially crosses through, getting to overbought, high beta stocks slowly recovering, and excessive outflows in IWM and SPY could fuel a tactical bounce.
   
  • Remember, this was a beta-driven correction, not a momentum-driven one.
    
    
• Bullish signals may re-emerge if a high percentage of stocks move about their 20dma and hit 20-day highs, suggesting a reassertion of the bull trend.
  
  
• Despite heightened policy uncertainty and a dark cross in tech, strong credit markets and sentiment tied to returns suggest the current pessimism may be overdone.
  
  
• Semi's continue to weaken, with even "good" ones coming under pressure.
  
  
• Staples pulled back at resistance levels, maintaining relative downtrend. Sharp unwind in beta and extreme underperformance suggests continued downward pressure.
  
  
• Transports reiterate bearish trend but flagging oversold and in "seller's frenzy". Expect short-term tactical bounce but fade the move.

Policy

• Debt limit deadline ("X-Date") likely between July and October, with resolution hinging on reconciliation or bipartisan deal amid uncertain cash flows.
   
  • Delays risk market volatility and a Moody's downgrade, raising U.S. borrowing costs.
    
    
• Trump will announce reciprocal tariffs on April 2, targeting about 15 key partners; recent moves on oil, autos, and threats to the EU and Canada may be strategic leverage.
  
  
• Section 232 is being used more broadly to justify tariffs on national security grounds, covering autos, copper, timber, and pharma, with an emphasis on U.S. production.
  
  
• Tariff timing and scope remain unclear, with Trump using them as a flexible tool, adding to market uncertainty.