US EARLY MORNING: Index futures are continuing to the downside today after Wednesday’s slide

US equity futures are continuing to the downside (YM -0.9%, RTY -0.9%, ES -1.0%, NQ -1.3%) following Wednesday’s worst day for US stocks since June 2020. Treasuries are bid, with yields lower by around 3bps across the curve, while the shape of the curve is biased towards slight steepening. Grim earnings reports from US retailers have exacerbated growth and inflation concerns, leaving little for the bulls to rally behind. ECB minutes today may offer clues about its own tightening trajectory. In the US, weekly jobless claims are due, while the Philly Fed will be eyed after the Empire Fed manufacturing survey or May disappointed.

NO CATALYSTS FOR BULLS: Grim retail earnings reports have exacerbated concerns about global inflation and growth, all at a time when central bank officials are reiterating commitments to tighten policy (possibly into restrictive territory) to put a lid on rising consumer prices – crucially, these officials have not relented on their hawkishness in remarks given this week. Although the growth impulse in China is becoming more constructive as the nation’s COVID situation improves and policymakers announce actions to support the economy, it still faces challenges around its zero tolerance policies. Meanwhile, the situation in Ukraine–which is wreaking havoc on energy and agricultural markets–continues with no meaningful signs that we are moving towards a more peaceful outcome. This concoction of factors here has left very few explicit catalysts for the bulls to latch-on to, and has made selling ‘bad news’ easy for traders.

RECESSION RISKS: The sell-side is also strategizing on how recessions will impact stocks, even though the consensus on the sell-side–and among officials too–is that a recession can be avoided. The fact that the conversation is even being had is enough to add caution into risk sentiment. The folks at Goldman Sachs, for instance, have been discussing how S&P 500 price, earnings, valuations, sector and factor performance have fared in past recessions; it notes that in the 12 recessions since World War II, the S&P 500 index has fallen from peak to trough by a median 24%; since 1948, S&P 500 earnings have dropped from peak to trough around recessions by a median of 13%, while the S&P 500 forward P/E ratio has contracted by a median of 21% between the pre-recession peak and the eventual trough.

IMPACT ON STOCKS: Capital Economics’ analysts have been arguing that it is only a matter of time before the S&P 500 re-enters bear-market territory, and sees the index slumping to 3,750 by the middle of next year (which would be a peak-to-trough decline of around 22%). “The current struggles of the S&P 500 don’t have much in common with most previous bear markets, but we still think one is likely as the Fed presses ahead with monetary tightening,” it writes. CapEco notes that most previous S&P 500 declines into bear market territory have been accompanied by recessions, and while it sees recessionary risks as elevated due to falling real incomes and tighter monetary policy, it does not have a recession in its base case. “One driver of big falls in equity prices that need not be associated with a recession is a large increase–and subsequent unwind–of the valuation of equities relative to other assets, but that doesn’t seem to be present this time either.” They say that a better historical comparison would be with previous tightening cycles; since the 1980s, these previous episodes of tightening have usually coincided with upside in the S&P 500, but it says that the main difference between now and then is the increase in discount rates this time around, and accordingly, the change in equity valuations has been much larger and much quicker, reflecting valuations being higher at the start of this year than going into the previous cycles, while the reassessment of the monetary policy has been rapid. It says that if the current woes of the S&P 500 are a function of monetary tightening, then it argues that any recession could drag the index a lot lower, but if the economy avoids a recession, CapEco says the bottom for equities may come when the pressure from monetary policy on valuations eases-that could still be some time away.

DAY AHEAD: Commentary from ECB officials–who have generally been amongst the more dovish G10 central bankers in recent years–is also starting to tilt towards tightening; further insight may be gained today with the release of the ECB’s latest meeting minutes (our primer is here); analysts believe that the central bank will use its June meeting to telegraph rate rises once its asset purchases conclude in Q3, leaving potential to inject further hawkishness into today’s market narrative. Elsewhere on the economic docket, the US will release weekly jobless claims data, while the Philly Fed manufacturing report will be eyed after the weak NY Fed manufacturing data for May. EMFX traders will be watching the SARB rate decision (+50bps expected, our primer can be found in the week ahead preview here). Our full ‘Day Ahead’ calendar can be accessed here.

KEY US EQUITY LEVELS (per Credit Suisse):

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19 May 2022 - 09:30- EnergyResearch Sheet- Source: Newsquawk

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