During the same week that saw the Fed’s preferred inflation gauge (PCE) rise more than expected, consumers expect far higher levels ahead. The University of Michigan’s sentiment survey also inquires about the inflation outlook. Americans think inflation will average 5% in the next year (red line below), which is up from 4.3% in February. Over the next five years, inflation is expected to average 4.1% (blue line below), which is up from 3.5% in the prior month and is the highest level since 1993.
Along with negative headlines, bearish technical conditions helped reject the S&P 500 off a key level. But those same technicals could point to a bullish momentum divergence if the S&P retests the lows. After bottoming near the 5,500 level on March 13, the S&P rallied back toward the 200-day MA which is the green line in the chart below. As the S&P tested that level from below, the MACD and RSI were both making bearish momentum resets with the MACD under the zero line and RSI holding under 50. But with last week’s drop, the S&P could retest or undercut the March 13 lows. If that happens, watch for the MACD and RSI to make a higher low which could deliver a bullish momentum divergence.
Heading into the February peak for the S&P 500, the market’s largest stocks made up a record share of the index. The “Magnificent 7”, which includes names like Apple (AAPL) and Nvidia (NVDA), are a big driver of the concentration and were responsible for 55% of the S&P 500’s 23% gain last year. But the record weighting leaves the major indexes vulnerable to downside when investor moods toward the Mag 7 sours. That’s especially the case recently since the Mag 7 carries high exposure to sales coming from international sources. The Mag 7 receives 49% of revenues from outside the U.S. That compares to 26% for the remaining stocks in the S&P (chart below). That leaves the Mag 7 more exposed to developments around tariffs and trade wars, and could also be the target of retaliatory measures from other countries.
Mega-cap stocks are a major contributor to the S&P 500’s recent correction. For signs that the S&P 500 could stabilize and recover, then watch the performance of the average stock. That’s especially the case if the S&P 500 retests the March lows. One key breadth metric to follow is net new 52-week highs, which takes 52-week new highs across the major exchanges and subtracts new lows. The chart below shows net new highs and the S&P 500 during two corrections in late 2015 and early 2016. During each instance, the arrows show where the S&P 500 is retesting the low on each correction. The circled area shows shrinking net new lows on each retest, highlighting the improvement in the average stock.
While the Mag 7 is helping drive near-term volatility, a recovery in the stock market will ultimately come down to earnings. Over the long-term, the path of corporate earnings ultimately drives stocks prices. That means the economic outlook needs to stay intact if the S&P 500 can recover following the drop into correction territory. The chart below plots the average direction of the S&P 500 following a correction, and is conditional on the economy falling into recession or not. The blue line shows the path when recession is avoided, where corrections deliver a “buy the dip” opportunity. The green line shows the path when a recession occurs, which tends to see new lows for the S&P after falling into correction.
Inflation is one factor weighing broadly on stock prices, but other sectors with a positive correlation to inflation are showing relative strength. Gold prices are moving out to record highs, and the energy sector is historically among the best performing S&P 500 sectors during periods of high and rising inflation. At the same time, a period of bullish seasonality is about to hit energy stocks. The chart below shows the average movement of the Energy Select Sector SPDR Fund (XLE) during the calendar year. XLE is approaching a period of strong seasonality for the next few months.
