Private capital stocks are weak across the board, says Strategas' Verrone

Key Concepts:

• Market Volatility
• Consumer Discretionary vs. Defensive Stocks
• Federal Reserve Policy Rate
• Yield Curve (2-year, 10-year, 30-year)
• AI Beta Positioning
• Market Breadth and Internals
• Technical Analysis (Top Formations, Oversold Conditions)
• Sector Rotation (Tech, Financials, Healthcare, Utilities)
• Stock Examples (Nvidia, Salesforce, Workday, ServiceNow, Apollo, Blackstone)

Market Outlook and Economic Perception

The current market environment is characterized by a bout of volatility, prompting questions about the potential for an end-of-year rally. Chris Ferrone, Head of Technical and Macro Research, suggests that the market's perception of the economy has shifted over the last two to three months. This shift is evidenced by the relative weakness observed in consumer discretionary stocks compared to defensive sectors like healthcare and utilities, which have shown signs of leadership.

Federal Reserve Policy and Bond Market Dynamics

Ferrone argues that the Federal Reserve needs to align its policy with the economic signals being sent by the market. The current yield on the two-year Treasury, around 3.55%-3.60%, is still two cuts below the policy rate. This suggests that the bond market is anticipating further rate cuts. The backing up of long-term yields, particularly the 30-year yield, since the last Fed meeting, and the 10-year yield moving back above 4%, is seen as a tricky aspect of the current call. Ferrone expresses surprise if 10-year yields were to significantly exceed 4.35%-4.35% in this environment, viewing that as a potential buying opportunity for bonds. He believes the Fed will ultimately have to cut rates, and the question is whether the bond market will force a sooner and more aggressive cut than the Fed desires.

Market Uncertainty: AI Beta Flush or Fundamental Rethink?

The market appears to be caught between two interpretations of the recent volatility:

1. A flush of weak hands in crowded AI beta positioning: This suggests that the recent downturn is a correction in speculative, AI-related trades.
2. A fundamental rethink of the shape of the economy: This implies a deeper concern about the underlying economic trajectory.

Ferrone leans towards giving the market the benefit of the doubt, noting that the market is still in an uptrend with generally good leadership throughout the year. He believes that market breadth and internals are not as poor as some might suggest. However, he posits that a significant "flush" or oversold condition might be necessary to prompt the Federal Reserve to act more decisively, particularly in anticipation of the December meeting.

Technical Levels and Potential Catalysts

Ferrone highlights key technical levels to watch. He mentions the S&P 500 potentially undercutting the 46640 level, with limited support until around 4450. An oversold condition at these levels could be a catalyst for the Fed's attention.

Concerns Beyond Nvidia and Semis

While Nvidia and other semiconductor stocks have experienced significant gains, Ferrone is not primarily worried about them forming top formations. Instead, his concern lies with legacy software companies and other tech names that have been exhibiting distributive top formations throughout the year. Examples include Salesforce, Workday, and ServiceNow. He emphasizes that these stocks have not participated in the broader market rally and are already "left out in the cold." If the "good stuff" (like Nvidia) falters, it is these weaker names that will bear the brunt of the downside.

Sector Weakness and Financials Example

Ferrone uses the financial sector as an example. While banks have performed well, private capital and alternative asset managers have been weak. He suggests that if the banks begin to falter, the real shorts would be in names like Apollo and Blackstone, which are already down significantly. He concludes by stating that "all the big mistakes in this business happen."

Synthesis and Conclusion

The market is navigating a period of volatility, with signals pointing towards a defensive shift and an economy that may be weakening more than the Federal Reserve is currently acknowledging. While speculative AI positioning might be a factor, a deeper fundamental concern about the economic outlook cannot be dismissed. Technical levels and oversold conditions could act as catalysts for Fed action. The focus of concern is shifting from high-flying tech stocks to those that have already underperformed, suggesting that a broader market downturn could disproportionately impact weaker sectors and companies. The bond market appears to be pricing in more aggressive Fed cuts than the Fed itself is signaling, creating a potential point of tension.