The market wants a soft landing for the economy. Why it may not get it

What does the stock market want? Two things: an easing of supply chain issues and a soft landing for the U.S. and global economy. The first is showing signs of improvement. The second is going to be more elusive. Daimler Truck became one of the latest companies to say they were pushing past the global chip shortage. Other companies such as Foxconn have also made comments recently that global supply chain issues were improving. Goldilocks is the soft landing everyone wants, but it is proving very elusive. The market is running headlong into a simple problem: It needs economic data to be Goldilocks, and it’s not working out that way. If the data is too strong, the Federal Reserve will keep hiking. If it’s too weak, there will be fears of recession. May ISM Manufacturing on Wednesday was a tad too hot (56.1 vs. 54.1 expected), and the market fell apart. Stocks dropped immediately, and bond yields shot up. Traders are terrified of recession and of a strong economy. It makes everyone crazy, and it’s the main reason high conviction is in such short supply. Goldilocks is also expected from Friday’s ISM Services report (56.7 expected by Dow Jones, down from 57.1) and nonfarm payrolls (328,000 expected for May, down from 428,000 in April). If they are close to these Goldilocks expectations, it will reinforce the idea that the Fed may indeed pause after hiking 50 basis points in June and July. If they are much hotter, it’s likely we may get the same reaction we got to the ISM Manufacturing on Wednesday. That lack of conviction is one reason BTIG chief market technician Jonathan Krinsky believes this summer is going to be very choppy. “It was too easy to be short in May,” he told me. Krinsky also thinks the market does remains in a downtrend. “I think we are going to 3,400-3,500 but it is going to be choppy,” he said, noting that 3,400 was roughly the pre-Covid highs in February 2020. Is there some mean reversion coming? You would think that with the enormous outperformance of energy this year, Krinsky would be bullish on the sector. But he points out that the Energy Select Sector SPDR Fund (XLE) is 39% above its 200-day moving average. With the exception of a brief period in March 2021, that is as wide as the spread has ever been. “Momentum is good until it gets to an extreme, and this is an extreme,” Krinsky said. “If you are buying Energy here, you are saying it is going to continue to remain in a bigger extreme than it has been in for the last 22 years. I’m playing for mean reversion.” Others may be on to this as well: There were surprising outflows from energy ETFs in May, at the same time the sector was the biggest gainer.

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